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Suppose we are in an economy with only two kinds of investment, business investment and residential investment. Suppose also that government gives tax-credit on business investment. Will there be a substitution effect like the one happens in microeconomics where the demand curve for residential investment is shifted downwards and the demand curve for business investment is shifted upwards? I mean, a textbook would say there will be an upward shift for business investment demand curve and no changing in residential investment curve. Any comments will help!

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I think we should regard these more like supply curves. Moreover, I will regard this economy being composed of agents with heterogeneous levels of profitability ratios between business and residential investment.

In the business side, there will be an average return on investment curve, and at lower investment levels, there will be higher returns and vice versa, which makes this look more like a demand curve. Moreover, this might be regarded as an exogenous curve in your scenario.

From the perspective of investors, when the average return on investment is low, only those who have higher levels of private returns to investment (compared to residential investment) will invest in business and more people will be attracted to business investment as the return increases.

A similar picture would hold for the residential investment. The economy arrives at an equilibrium when each of these markets are in equilibrium.

A person would allocate his wealth among his choices based on the additional gains per cost of each alternative. Here, when you have lower the cost of business investment by reducing taxes, all agents will find business investment comparably desirable, and there will be less people investing in residential industry.

So the supply in residential investment will be lower simultaneously with the increase in supply of the business investment.

Of course you can consider scenarios in which an investor's optimal decision requires diversifying to some degree, but as long as the complementarity is not extremely strong, which would be expected in this case, the economy-wide supply curves would shift in opposing directions.

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