2.2.3 Investment

INVESTMENT

• addition of capital stock to the economy i.e. machines and factories used to produce other g and s

• only seen as investment if real products are created- so buying a share in a company would be saving but buying new machinery is investment

GROSS AND NET INVESTMENT

• machinery depreciates (loses its value) over time as it wears out or gets used up

• gross investment- amount of investment carried out and ignores the level of depreciation

• net investment- gross investment minus value of depreciation

INFLUENCES ON INVESTMENT

• rate of economic growth

• business expectations and confidence

• demand for exports

• interest rates

• influence of gov and regulations

• access to credit

• retained profit

• technological change

• costs

RATE OF ECONOMIC GROWTH

• growing economy= higher levels of investment as businesses more confident and higher demand would lead to higher return rate on investment

• e.g. buying new machine would lead to more products being made, but if economy was declining these products wouldn't be bought so there would be no or little return on investment

• if same products and same output is being produced every year, and no more is demanded, investment will stay equal as firms only have to replace old machines

• but if economy is growing, firms will need to increase investment to match higher demand

• if shrinking, firms wont need to replace their old machines and so investment will fall

BUSINESS EXPECTATIONS AND CONFIDENCE

• when businesses confident and expect future growth, investment will increase

• if fearful, then they wont invest money in new ideas or machinery

• Keynes used term 'animal spirits' to describe feeling of owners of firms on whether their investment would be profitable

• argued that its difficult to measure

DEMAND FOR EXPORTS

• if economy booming, demand for exports likely to increase

• so exporting firms' investment likely to increase to cope with extra demand

• will have knock-on effect and encourage other firms to increase their investment

INTEREST RATES

• most investment is done through borrowing

• high interest rates means borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing

• other investment is done through retained profits or savings

• rise in interest rates increases the OC of a business using retained profits as they’re able to get higher interest payments than before

• Keynes' Marginal Efficiency of Capital (MEC) graph shows how higher interest rates will lead to a fall in investment

• displays the expected rate of return from an investment at a particular given time

INFLUENCE OF GOVERNMENT AND REGULATIONS

• gov can encourage investment by their own policy decisions

• e.g. they could offer tax breaks or grants to businesses to try and encourage them to invest

• regulations also affects investment as a highly regulated economy tends to see less investment as it increases cost and time, such as planning regulations

ACCESS TO CREDIT

• investments will be lower when they have a high risk attached to it- means there will be less access to credit and interest rates will be higher

• in recessions- usually more difficult to access credit as risks are higher and banks fear firms will not be able to pay the money back

RETAINED PROFIT

• profits kept by a firm and not shared w/ shareholders or used to pay taxes

• not all firms take into account the OC of investment from their retained profits i.e. the interest gained from keeping it in a bank account

• many firms are also unwilling to borrow money for investment in case the investment fails to make a profit and they’re unable to pay it back.

• so if firms are making higher retained profits, investment is likely to increase as they have more money

TECHNOLOGICAL CHANGE

• improvements in tech will improve or speed up production- increases level of profitability so investment has a better prospect of success

• change also means businesses need to invest to keep up with the best tech

COSTS

• rise in the cost of any capital project increases level of risk and leads to lower levels of investment

• rises in the costs of making goods, such as the raw materials and wage, will decrease investment as it will reduce profitability

• means firms have less money to invest and decreases the rate of return on their investment