2.2.3 Investment (I) Flashcards
Investment
Money spent by firms on assets which they’ll use to produce goods or services – this includes things such as machinery, computers and offices.
Gross investment
All investment spending.
Net investment
Only includes investment that increases productive capacity.
E.g. if a firm has 3 old trucks, but replaces these with 5 new trucks, the gross investment is ‘5 trucks’ but the net investment is ‘2 trucks’.
What percentage of AD does investment make up?
15%
How is investment funded?
Typically through:
- Loans (Commercial from banks or government loans)
- Savings spent (Retained profits)
What does it mean if a company’s net investment is positive?
The company is expanding.
What does it mean if a company’s net investment is negative?
The company is shrinking.
What factors affect investment?
- Risk
- Government incentives and regulation
- Interest rates and access to credit
- Technical advances
- Business confidence and ‘animal spirits’
What is capital depreciation?
The decline in the value of an asset.
- For example, if a machine is bought for £10,000 but only has a lifespan of 5 years, then every year, the value of this machine will decline by £2,000.
How does technological advances affect investment?
Firms need to invest in new technology to stay competitive. Investment will rise when significant technological advances are made.
How does business confidence and ‘animal spirits’ affect investment?
The more confident a business is in its ability to make profits the more money it’s likely to invest.
But ‘business confidence’ depends partly on the general optimism or pessimism of the company’s managers. Keynes recognised that not all investment decisions are based purely on reason and rational thinking, and that human emotion, intuition and ‘gut instinct’ are also important factors. He called these factors ‘animal spirits’.
How do interest rates affect investment?
Firms often borrow the money they want to invest. This means that when interest rates are high or firms are unable to access credit, investment tends to be lower.
High interest rates would reduce how profitable an investment would be (since interest charges on loans will be higher).
High interest rates also means there’s a greater opportunity cost of investing existing funds instead of putting them into a bank account with a high interest rate.
How do government incentives and regulation affect investment?
Government incentives such as subsidies or reductions in tax can affect the level of investment. For example, a reduction in corporation tax might encourage firms to invest, because they’ll have more funds available to do so.
A relaxing of government regulations might reduce a firm’s costs and make it more likely to invest.
How does risk affect investment?
The level of risk involved will affect the amount of investment by firms.
If there’s a high risk that a firm won’t benefit from its investment, then it’s unlikely that the firm will invest. For example, when there’s economic instability, less investment will be made.
