A Behavioural Model of Investment Appraisal and its Implications for the Macroeconomy

Michelle Baddeley and Geoffrey Harcourt

No 2021/05, Working Paper Series from Economics Discipline Group, UTS Business School, University of Technology, Sydney

Abstract: Sub-optimal levels of investment in fixed capital are a pressing problem for modern economics. Behavioural economics provides some potential explanations, but behavioural economic insights are not commonly incorporated into standard capital investment models which capture neither the diversity of investment appraisal techniques used in practice, nor the range of decision-making styles used by real-world businesses. In filling these gaps, this paper brings together insights from capital investment theory with insights from behavioural economics to develop a behavioural economic model of investment appraisal, allowing for boundedly-rational investment decision-making. This model is applied in a macroeconomic analysis to show how the misapplication of investment appraisal criteria, especially under conditions of endemic uncertainty, is associated with sub-optimal levels of macroeconomic investment - with negative macroeconomic implications in terms of production, employment, productivity, wages and cyclical volatility.

Keywords: investment; heuristics; bias; behavioural macroeconomics (search for similar items in EconPapers)
JEL-codes: D22 D25 E29 E70 M21 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2021-08-01
New Economics Papers: this item is included in nep-cwa, nep-isf, nep-mac, nep-pke and nep-upt
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