2.2.3 Investment

Question 1

What is investment

Answer 1

Is the purchase of goods that are not consumed today but used in the future to create wealth

(spending on Capital goods)

Question 2

What is included under the Capital goods, bought in investment

Answer 2

plant and machinery and infrastructure

cultivated assets (livestock and vineyards)

intellectual-property products - investment in software, research, and development (intangible fixed assets)

Question 3

What is a Capital good

Answer 3

factories and machinery and equipment are useful not in themselves but for the goods and services they can help produce in the future

Question 4

What is the difference between a Capital good and financial capital

Answer 4

financial capital are funds that are available to finance the production or purchase of real capital

Question 5

What is gross investment

Answer 5

total investment on new capital inputs

Question 6

What is Net investment

Answer 6

Is gross investment adjusted for capital consumption (depreciation)

Some new investment is needed each year to replace worn out machinery

Question 7

If gross investment in a given year is higher than Capital consumption….

Answer 7

net investment will be positive and the size of an economy’s capital stock will grow

Question 8

Since 1970, UK investment has been on average X% of GDP per year. For other developed countries, the average has been Y%

Answer 8

X=20

Y=24

Question 9

Why does investment happen

Answer 9

• Replace worn out capital which has depreciated in value
• New technology that will make firms more efficient (however this is not always the case)
• Increases in aggregate demand that result in firms needing to increase capacity
• Change in interest rates and the number of loans available from banks (with an increase in demand, there is usually increasing investment too)
• Changes in profit made by business which can be re-invested

Question 10

What are the 6 factors that will affect levels of investment

Answer 10

• 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

Question 11

How do interest rates affect the level of investment

Answer 11

If interest rates are low in the economy, it means that the cost of borrowing is low, hence a greater incentive to borrow money and invest.

Therefore, the marginal propensity to invest will increase with interest rates being lower.

Question 12

Which are the two way, firms fund investment

Answer 12

borrowing money or by reinvesting retained profits.

Question 13

What is the hurdle firms have when it comes to investment

How does this link to investment

Answer 13

is the required rate of return firms need for investment projects to go-ahead

It becomes easier if interest rates are lower, and increasing the marginal propensity to invest

Question 14

How can business expectations and confidence affect rates of investment

Answer 14

Businesses have two main expectations: future profits and demand

If those expectations are high going forward, then businesses are more likely to reinvest.

The marginal propensity to invest will be greater, to meet the level of demand in the future

Question 15

How does the level of corporate tax affect levels of investment

Answer 15

Retained profit, is the profit left after corporation tax has been paid

The lower the corporation tax, the higher the level of retained profit, the greater potential the businesses have to invest

Question 16

How does the cost of capital affect the levels of investment

Answer 16

If the price of Capital is low, investment is less costly, and margin propensity to invest will increase, so investment will increase

Question 17

How will having spare capacity affect the levels of investment

Answer 17

If a business has a high amount of spare capacity, there is no need to invest in capital machinery.

Supply can be increased using spare capacity

Question 18

How will levels or competition affect the levels of investment

Answer 18

If competition is strong, and lots of competitions are improving their technology or spending more on capital machinery, increasing efficiency.

The likelihood is businesses will react to that and also invest

To get ahead of competitor, invest in capital, which is more efficient or new technology

Question 19

What is animal spirit

Answer 19

refers to a mix of confidence, trust, mood, and expectations

When confidence is low, individuals save more, businesses save more too and, because demand and profits
are lower than expected

Therefore there is a cut back on production and perhaps postpone or cancel capital investment projects

Question 20

What is the idea of Paradox of thrift

Answer 20

Higher saving and reduced investment both reduce demand and incomes, causing an economic contraction

It is a paradox because it makes sense for individual households to
increase savings if they are concerned about their future

the combined effect of rising savings is that less is spent in the economy, and therefore businesses will demand fewer workers

Question 21

What is the short term impact on a PPF, on spending more on macro goods

What is the long term impact on a PPF, of spending more on macro goods

Answer 21

Short term: shift from a to b

Long term: Shift in the curve outward

Question 22

On a micro level: investment in injection into the circular flow of income - component of AD, what is the problem with this

Answer 22

Some of the capital good may be imported - this is a leakage from the circular flow

Question 23

On a macro level: new capital can aid productivity and create additional capacity to supply - what is the problem with this

Answer 23

Might be a long time lag between workers getting more capital and productivity rising

Question 24

on a macro level: investment creates extra demand in investment good industries and can lead to a strong multiplier effect on the level of GDP - what can be the problem with this

Answer 24

Some capital investment replaces labour and therefore might cause some short term unemployment

Question 25

On a macro level; investment will support a country’s competitiveness and therefore improve the trade balance in goods and services - what is the problem with this

Answer 25

many other factor affect competitiveness - including level of exchange rates

Question 26

What is the accelerator effect

Answer 26

is a relationship between planned capital investment and the rate of change of national income

where a given change in demand for consumer goods and services will cause a bigger percentage change in demand for capital goods

Question 27

Give examples of the accelerator effect

Answer 27

• Investment to create extra capacity in cloud computing storage services
• investment in 4G mobile networks to meet rising household and business demand
• Expanding fleet sizes in growing airlines
• Capital investment in renewable energy as the balance of energy supply shifts towards renewables

Question 28

Describe the negative accelerator effect

Answer 28

When the growth of demand in an industry slows, net investment spending by businesses often falls.

Question 29

Economic significance of infrastructure investments

Answer 29

Potentially high multiplier effects from multi-billion investment projects – increase AD and jobs

Lack of infrastructure may discourage FDI (foreign direct investment)

Increases the capital stock / productive potential

Allows sustainable growth

Question 30

Examples of current and recent UK infrastructure projects

Answer 30

2nd Fourth Road bridge

Crossrail, Crossrail2, and HS3 (Leeds-manchester)

London Gateway port and new London super sewer

Nuclear power plants