2.2.3: Investment

What is gross investment?

• The amount that a firm invests in business assets that does not account for depreciations

• Net investment + Depreciation

• Gross investment is the I in AD

• A depreciation is when something starts to lose value

• If the depreciation in the value of the capital is greater than the growth in gross investment, there is a decrease in the value of capital in the economy and there is no economic growth

• High gross investment doesn’t always mean growth- could just be replacing old capital

What is net investment?

• The actual addition to the capital stock of an economy after depreciations have been considered

• Doesn’t include the replacement of old capital

• Net investment= gross investment - depreciation

• Positive net investment means capital stock is increasing and growth is occuring

• Zero means the economy is just replacing capital

• Negative means that capital stock is shrinking

• Is better than gross investment for showing long term growth potential

Influences on investment: The rate of economic growth

• If growth is high, firms will be making revenue due to higher rates of consumer spending

• This means they have more profits available to invest

• If growth is low, there will be weak consumer demand and therefore lower expected returns- which results in decreased investment

• Investment depends in expected future growth, not just current growth

• Time lags may also delay investment decisions

Influences on investment: Business expectations and confidence

• If firms expect a high rate of return, they will invest more- firms need to be certain about the future, otherwise they will postpone their investments

• Also, expectations about society and politics could affect investment

• E.g: if a change in government might happen, or if commodity rices are due to rise, businesses may postpone their investments decisions

• Keynes coined the term animal spirits when describing instincts and emotions of human behaviour which dries the level of confidence in an economy

Influences on investment: Demand for exports

• This is related to the rate of market demand- the higher demand is, the more likely it is that firms will invest as they are expecting high future profits

• This is due to the fact that they expect higher sales, so they might direct capital goods into the markets where consumer demand is increasing

• Moreover, high interest rates might make firms expect a fall in consumer spending, which is likely to discourage investment

Influences on investment: Access to credit

• If banks and lenders are unwilling to lend, firms will find it harder to gain access to credit so it is either more expensive or not possible to gain the funds for investment

• Firms could use retained profits, however the availability of funds is dependent on the level of saving in the economy

• The more consumers are saving, the more available funds are for lending and therefore investing

• However this is more important for small firms as they have less internal funds

• Even if credit is available, firms may not invest due to low animal spirits

Influences on investment: The influence of government and regulations

• The rate of corporation tax could affect investment due to lower taxes means firm keep more profits, which could encourage investment

• Subsidies, tax breaks and grants could also encourage investment

• However high levels of regulation would discourage investment- higher taxes and stricter rules e.g labour laws increase costs and decrease a firms profitability which therefore decreases investment

• Deregulations reduce barriers to entry and reduce costs for firms

• A cut in corporation to encourages firms to expand