INVESTMENT

investment is the spending on capital stock of the economy , including factories , machines , offices and stock of materials used to produce good and services. It is 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.

the value of the capital stock depreciates over time as it wears out and is used up , this is called depreciation or capital consumption

gross investment measures investment before depreciation , whereas net investment is gross investment less the value of depreciation

TWO TYPES OF INVESTMENT :

• investment in human capital , which is the investment in the education and training of workers

• investment in physical capital , which is the investment in factories and such

investment is done by both the public and private sector, since the public sector is constrained by complex political considerations, when talking about investment , we refer to the ones done by the private sector

GROSS AND NET INVESTMENT :

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

gross investment is the amount of investment carried out and ignores the level of depreciation,

whilst net investment is gross investment minus the value of depreciation.

For example, if a firm was to buy 5 new machines then the gross investment would be the value of these 5 machines but if they also got rid of 2 old machines then the net investment would be the value of the 5 machines minus the value of the 2 old machines. The distinction between net and gross investment is important as in the UK depreciation accounts for about 75% of gross investment .

DETERMINANTS OF INVESTMENT :

• rate of interest: Most investment is done through borrowing. High interest rates mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing. Keynes’ Marginal Efficiency of Capital (MEC) graph shows how higher interest rates will lead to a fall in investment. the higher the rate of interest , the lower the profit that results from the investment. some investment is also financed by retained profit , so when interest rises it becomes more worthwhile to keep the retained profit in the bank as the business will get higher returns , so investment in the economy falls

• business costs: an increase in business costs such as wages or raw materials will reduce the profitability or rate of return on investment ( ROCE? ) which will decrease the level of investment made in the economy

• the rate of economic growth: if the same products are being produced in the same amount in an economy year after year , firms will only reinvest enough to cover for the depreciation and keep production at the same level. if the economy is expanding , then firms will have to increase their investment to have the capital equipment to produce more goods and services but during recessions , firms will not to reinvest the same amount as before as they know it would be wasteful.

• business expectations and confidence: When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not invest money in new ideas or machinery. John Maynard Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable.'naive optimism’ where entrepreneurs who are encouraged by rising markets , tend to take too many risks which leads to higher investment

• the world economy: if the world economy is growing rapidly, then demand for exports is likely to increase. this in turn , should lead to a rise in domestic investment as businesses will have more opportunities to expand and sell goods in a wider market. If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment.

• availability of credit: Investment will be lower when an investment has a high risk attached to it, as it means there will be less access to credit and interest rates will be higher. In recessions, it is usually more difficult to access credit as risks are higher and banks become more risk aware, fearing firms will not be able to pay the money back.

• retained profit: retained profit is the amount of money left to businesses after all expenses, taxes and dividends have been paid to shareholders. if the businesses has higher levels of retained profit , they are likely to invest more as they will still have money left after investment. if corporation taxes are lowered , it will become easier for the business to invest more. Many firms are also unwilling to borrow

  money for investment in case the investment fails to make a profit and they are

  unable to pay it back. Therefore, if firms are making higher retained profits,

  investment is likely to increase as they have money available to invest.

• influence of government and regulation: cutting profit taxes may help businesses invest more , this is called tax relief. the govt. can also help by guaranteeing loans made by banks to firms for investment. this is helpful as the banks will be more willing to give out loans which will stimulate investment , and the government will pay back in case the business fails to return the money.