Confidence was recognized as an important component of the investment decision by Keynes in his General Theory. Over time, rational expectations and highly mathematical, dynamic optimization models have driven such notions from the investment literature. However, careful specification of a format, dynamic optimization problem allows the ‘state of confidence’ to be reincorporated without violating the rational expectations hypothesis. A simple model of the firm is employed to establish approximate bounds on the potential impact of confidence on investment. The relative importance of confidence is shown to be determined largely by the levels of adjustment costs and demand uncertainty present.
