2.2.3 Investment

What is investment?

Investment= firms spending money of capital goods to increase their productive capacity// addition of capital stock to the economy.

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

What is investment spending also called?

Investment spending is also called=

• capital stock (spending)

• physical capital

• fixed assets

• non- current assets

What is gross investment?

Gross investment=

the amount of investment carried out and ignores the level of depreciation

What is net investment?

Net investment=

gross investment- value of depreciation

Why is the distinction between net and gross investment important?

Distinction between net and gross investment is important as in the UK, depreciation accounts for about 75% of growth investment

What are the factors affecting investment?

Factors affecting investment=

• the rate of economic growth

• business expectations and confidence

• Keynes and ‘animal spirits’

• demand for exports

• interest rates

• access to credit

• the influence of government and regulations

How does the rate of economic growth affect investment?

Rate of economic growth affects investment=

in a growing economy, there will be higher levels of investment as businesses would be more confident about their investment and the higher demand will lead to higher return on investment. Growing economy needs more investment to cope with high demand

If the economy was declining, products (made from new machines) wouldn’t be bought, as there will be no or little return on investment

If there is the same output and same products and no more is demanded, investment will stay the same, as firms will only have to replace old machines

If the economy was shrinking, firms do not need to replace their machines, investment decreases

How do business expectations and confidence affect investment?

Business expectations and confidence affects investment=

when businesses are confident about the future and expect future growth, investment increases as they want to prepare for the future. Keynes used ‘animal spirits’ to describe the feeling of managers and firm owners on whether their investment would be profitable, but it is difficult to measure.

determined by expected profit and expected demand, so higher confidence means firms expect high future profit and demand→ firms are more likely to invest to meet future demand and capitalize on profit opportunities, so increases marginal propensity to invest. If vice versa, less needs to be invested in increasing capacity

How does the demand for exports affect investment?

Demand for exports affects investment= if there is an economic boom, demand for exports are likely to increase and exporting firm’s investment is likely to increase to cope with this extra demand: knock on effect (indirect consequence) and encourage other firms to increase their investment

How do interest rates affect investment?

Interest rates affect investment= since most investment is done through borrowing. High interest rates mean that borrowing is more expensive (so it decrease incentive to borrow for investment and decreases the marginal propensity to invest); so a business needs to be more confident of good profits in order to cover the extra costs of borrowing.

Higher interest rates increases opportunity cost of a business using retained profits as they are able to get higher interest payments than before

How does the access to credit affect investment?

Access to credit= investment will be lower when there is higher risk attached to it, as it means there will be less access to credit and the interest rates will be higher. In recessions, it is usually more difficult to access credit as risks are hgiher and banks are more risk aware, fearing firms are unable to pay the moeny back

How does the influence of government and regulations affect investment?

Influence of government and regulations affect investment=

goverments can encourage investment by their own policy decisions. for e.g. they could offer grants/ tax breaks to business to encourage them to invest.

Regulations affect investment as a highly regulated economy tends to see less investment as regulation increases costs and time taken to invest, such as planning regulations.

What is the accelerator effect?

Accelerator effect= an increasing rate of real GDP growth encourages further investment

If the economy is growing rapidly, firms anticipate higher future demand and profits, prompting them to invest more to expand capacity. This increase of investment can further boost GDP growth, creating a positive feedback loop

What is the accelerator theory?

Accelerator theory= the investment over a period of time is the change in real income times the capital-output ratio. The capital-output ratio is the amount of investment needed to produce a given amount of goods. Thus, if income increases, level of investment will increase.

What is gross investment also called?

Gross investment is also called “Gross Domestic Fixed Capital Formation”