2.2.3 + 2.2.4 + 2.2.5 Flashcards
What is investment?
- Spending on capital goods including plant & machinery and infrastructure.
What are capital goods
- goods used to produce other goods
Difference between gross and net investment
• Gross Investment: Total investment on new capital inputs
• Net Investment: Net investment is gross investment adjusted for capital consumption (depreciation)
o Some new investment is needed each year to replace worn out machinery, if gross investment in a given year is higher than capital consumption, net investment will be positive, and the size of an economy’s capital stock will grow.
Factors Influencing Business Investment
- Changes in business confidence
- Changes in interest rates
- Changes in technology
- Changes in business taxes
- Corporate indebtedness
- Access to credit
- Retained profit/ dynamic efficiency
Animal Sprits
- Keynes coined the notion of animal spirits which refers to a mix of confidence, trust, mood and expectations.
- Animal spirits fluctuate quickly as populations of people and the business community change their thinking.
What happens when consumer confidence low
Individuals and firms save more - they cut back on production and perhaps postpone or cancel capital investment projects. Economic activity suffers.
Evaluate this point : Investment is an injection into the circular flow of income – it is a component of AD
Some of the capital goods might be imported – this is a leakage from the circular flow
Also increase in capital goods could replace human labour, people may lose jobs (may need benefits - more gov spending)
Evaluate this point: New capital can aid productivity and creates additional capacity to supply
Might be a lengthy time lag between workers getting more capital and productivity rising
Evaluate this point: Investment will support a country’s competitiveness and therefore improve the trade balance in goods and services
Many other factors affect competitiveness – including the level of the exchange rate
The accelerator effect definition
accelerator effect is a relationship between planned investment and the rate of change of national income
How does he accelerator effect work
- Consider an industry where demand is rising quickly, firms may respond initially by using their existing capacity more intensively or running down stocks of finished products.
• If expect high demand will sustain = increase spending on capital goods in order to increase their supply capacity.
• causes a positive accelerator effect – where a given change in demand for consumer goods and services = bigger percentage change in demand for capital goods.
Economic significance of infrastructure
- Potentially high multiplier effects from multi-billion investment projects – increases AD and jobs.
- Lack of infrastructure may discourage FDI.
- Increases the capital stock / productive potential
Significance of government spending
- key component of AD
- has a regional economic impact
- important in providing public and merit goods
- can help achieve greater equity in society
Government revenue and the economic (trade or business) cycle
Gdp rise in boom/recovery =
- more in work = more income = more tax revenue
• business profit rise = more corporation tax
• more spending on goods and services = more VAT/Sales taxes
• people buy more assets = higher price of them = more revenue from capital gains taxes
Why will the government likely spend less when the economy is expanding
- less people out of work, = less spending on unemployment benefits.
•households see pay increases, so less spent on benefits.
• Some will choose to pay for private healthcare/ education, so there may be less spending needed on the NHS or schools.
• Crime levels lower when economy growing, = less spending on the police
Main influences on net trade balance:
- real income
- exchange rates
- state of world economy
- degree of protectionism
- non price factors
Real income
If domestic income high, then demand for imports will rise
- uk has relatively high marginal propensity to import (mpm), so when UK income rises, demand for imports tends to rise too
Relative prices of exports in world markets
This can be affected by domestic inflation, shipping/transport costs, fluctuations on world commodity prices
Non price demand factors:
Eg. Design and branding product quality, after sales services]
Strength of aggregate demand in key export markets
- state of world economy, eg, in 2020 the coronavirus pandemic is leading to global recession
- key export markets are booming, then they are likely to demand more exports
Trade balance and AD relationship
Trade surplus = X>M, meaning AD will increase
Trade deficit = M>X, meaning AD will Decrease
Influences on government spending
- trade cycle: eg, during recession there is more gov spending
- fiscal policy: decisions that affect government spending and taxation levels
- age distribution of population: older - more spending on pensions, social/ health care, younger - spend on education
Net trade =
Total exports minus total imports
Influences on net trade balance:
- changes in national income abroad, eg, if country B increases AD, it will consume more from country A, so more imports for B and more exports for A so AD goes up for A and down for B
- real income - higher - more demand for imported goods
- exchange rates - SPICED & WPIDEC
- state of world economy
- degree of protectionism (tariffs, quotas)
- non price factors
- prices
