2.2.3 Investmenf Flashcards
Investment
The addition to the capital stock of the economy
- this includes factories, machines, offices and stocks of materials used to produce goods and services
-additon to something as a result of the investment
Gross investment
The amount a firm invests in business assets that doesn’t account for depreciation (investment before depreciation)
Depreciation
Capital of asset/ stock loses its value (e.g. over time machinery loses its value)
Net investment
The actual addition to a capital stock of an economy AFTER depreciation
-the real value of an investment
- net investment= gross investment - depreciation
What are the influences on the rate of investment?
The rate of interest
The rate of economic growth
Costs
Business confidence
The world economy
Access to credit
Retained profit
The influence of government
The rate of interest on investment
-investment is financed by borrowing and there is interest paid on the loan
-higher rate of interest means lower profit that can be made of investment therefore there were be a lower rate of investment due to the reduced profitability (firms want to invest less)
-Some investment is financed by retained profit- higher rate of interest means it is more attractive for firms to save the money rather than invest hence there is less investment
Rate of economic growth
- if firms are growing they will need to increase investment to have the capacity to produce more goods to match the increased consumer demands of a growing economy
-if the economy is shrinking due to a recession, firms won’t need to replace all of their investment so the rate of investment will fall when there is a negative rate of economic growth - if the same amount is producers each year then the level of investment remains the same
Chain of reasoning of economic growth -> investment
If growth in economy
High employment
Higher average incomes
Increased consumption
Increased investment incentive for firms to increase capacity to meet future demands
What is the accelerator theory?
The idea that investment is linked to changes in output or income in the economy
- shows the relationship between planned capital investment and the rate of change of national income
What is the accelerator theory equation?
It = a( Yt- Y(t-1))
Investment in a given period of time= accelerator coefficient (capital output ratio)- changes in real income during year t
Chain of reasoning the accelerator effect
An industry with rapidly rising demand
-firms may respond by using their existing capacity more intensively or depleting current stocks
- if they expect high demand to be sustained, they may increase spending on investment to increase their capacity to supply
- this causes the accelerator effect ( a given change in demand for consumer goods will cause a greater percentage change in investment)
- change in investment will always be greater than the change in income/ output (firms anticipate demand to continue to rise so prepare to reach this level)
- if the firm doesn’t think the surge will be sustained over time, they won’t increase investment hence firms must be confident in the state of the economy which is difficult to predict
What is the capital-output ratio?
The amount of capital needed in the economy to produce a given quantity of goods
e.g. if £10 of capital is needed for produce £2 of goods then the capital- output ratio is 5
With a capital-output ratio of 4, an increase in the income of the economy by £1 billion will lead to an increase in investment of £5bn
The negative accelerator theory
If there is a negative growth rate, net investment spending will fall as firms spend less
-fall in GDP leases to a decrease in investment greater than the decrease of output
Costs
Private sector firms exist to make a profit
