2.2.3 Investment (Edexcel)

Question 1

What is investment?

Answer 1

• Spending on capital goods including plant & machinery and infrastructure.
• Business investment now includes cultivated assets (such as livestock and vineyards), intellectual property
  products (IPP, which includes investment in software, research and development, artistic originals and mineral
  exploration), and other buildings and structures

Question 2

What is gross investment?

Answer 2

Total investment on new capital inputs

Question 3

What is net investment?

Answer 3

It is gross investment adjusted for capital consumption (depreciation)
Some new investment is needed each year to replace worn out machinery - this is “depreciation”

Question 4

Explain what capital goods are and how they are different from financial capital.

Answer 4

• Producer or capital goods such as plant (factories) and machinery and equipment are useful not in themselves
  but for the goods and services they can help produce in the future.
• This is distinguished in economics from “financial capital”, meaning funds which are available to finance the production or acquisition of real capital.

Question 5

List some influences on investment

Answer 5

also including Access to Credit. Influence of Government and Regulations: Demand for Exports Rate of Economic Growth:

Question 6

How does rate of economic growth influence on investment?

Answer 6

When the economy is growing at a healthy rate, businesses are more likely to invest in new capital to meet increased demand.
Conversely, during economic downturns, investment tends to decline.

Question 7

How does business expectations and confidence influence on investment?

Answer 7

Positive expectations about future economic conditions and business prospects encourage investment.
High confidence in the economy can lead to increased capital expenditures.

Question 8

How does ‘Animal Spirits’ influence on investment?

Answer 8

John Maynard Keynes coined the term “animal spirits” to describe the emotional factors influencing investment decisions.
Confidence, optimism, and entrepreneurial spirit can drive investment even when rational analysis might suggest caution.

Question 9

How does demand for exports influence on investment?

Answer 9

Strong demand for a country’s exports can boost investment, especially in export-oriented industries.
For example, if foreign demand for a country’s automobiles is high, domestic auto manufacturers may invest in expanding production.

Question 10

How does interest rates influence on investment?

Answer 10

Low interest rates can reduce the cost of borrowing for businesses, making investment projects more attractive.
Higher interest rates can discourage investment due to increased borrowing costs.

Question 11

How does access to credit influence on investment?

Answer 11

The availability of credit, including loans and lines of credit, can impact a firm’s ability to finance investment projects.
During credit crunches, businesses may face difficulty obtaining funds for investment.

Question 12

How does Government and Regulations influence on investment?

Answer 12

Government policies, such as tax incentives and subsidies for investment, can encourage businesses to invest.
Regulations can affect the ease of doing business and the attractiveness of investment.
Real-World Example: During the 2008 financial crisis, businesses faced difficulty accessing credit due to a frozen credit market. This lack of credit availability contributed to a significant drop in investment in various sectors.

Question 13

Explain what animal spirits are.

Answer 13

• 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
• When confidence is low, individuals save more, businesses save more too and, because demand and profits
  are lower than expected, they cut back on production and perhaps postpone or cancel capital investment
  projects. Economic activity suffers.

Question 14

Explain what the paradox of thrift is.

Answer 14

Higher saving and reduced investment both reduce demand and incomes, causing an economic
contraction – this is called the “paradox of thrift”. It is a paradox because it makes sense for individual households to increase savings if they are concerned about their future (because savings provide a cushion against a loss of income), but on a macro level, the combined effect of rising savings is that less is spent in the economy, and therefore businesses will demand fewer workers… so what appears to be rational individual behaviour is irrational on a collective level.

Question 15

Explain macro effects of a rise in business investment

Answer 15

Question 16

Explain what the accelerator effect is.

Answer 16

The accelerator effect is a relationship between planned
capital investment and the rate of change of national income
* 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 they expect high demand will be sustained – they may increase spending on plant and machinery, factories
and new technology in order to increase their supply capacity
* This causes an accelerator effect – where a given change in demand for consumer goods and services will
cause a bigger percentage change in demand for capital goods

Question 17

What are examples of the accelerator effect?

Answer 17

Question 18

What is the negative accelerator effect?

Answer 18

When the growth of demand in an industry slows, net investment spending by businesses often falls. E.g. declining
investment in steel plants in a recession or cut-backs in investment when subsidies for renewable energy are cut.

Question 19

What is infrastructure investment?

Answer 19

• Spending on sewers, roads, wind farms, telecoms networks and ports by both private and public sector
• Infrastructure investment is vital for sustainable growth and research shows that the UK lags behind its major
  competitors in the quality of its infrastructure assets.

Question 20

Explain a benefit of infrastructure projects

Answer 20

Spending on infrastructure should cause both aggregate demand and aggregate supply to increase

Question 21

Explain a cost of infrastructure projects

Answer 21

Demands on infrastructure such as roads, railway, waste management, energy will rise along with economic
growth and a growing population

Question 22

What are examples of current and recent UK infrastructure projects?

Answer 22

2nd Forth Road Bridge
Crossrail, CrossRail2 & HS3 (Leeds - Manchester) London Gateway Port & new London super sewer Nuclear power plants including Hinkley Point

Question 23

Explain the economic significance of infrastructure

Answer 23

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

Question 24

What is a paragraph you can write about the effect of an increase in investment?

Answer 24

Investment is a component of AD, so an increase in investment will (ceteris paribus) lead to an increase in AD – this in turn leads to short-run (or “actual”) growth. Investment, because it is about the purchase of capital, will also lead to an increase in the economy’s productive potential, shown by an outwards shift in the PPF and the long-run aggregate supply (LRAS) curve. Therefore, investment also leads to long-run or potential growth.