2.2.3 - Investment (I) Flashcards
Gross & Net Investment
Gross -
The total amount of spending on capital goods
This spending includes replacing old capital goods and purchasing new capital goods
Net - Net investment takes into account the depreciation of capital.
o This metric provides information on the addition of new capital goods to an economy.
o It gives a better indication of the extra production possibilities that have been created through investment by firms.
What factors Influence investment
o The rate of economic growth
o business expectations and confidence
o Keynes and ‘animal spirits’
o demand for exports
o interest rates
o access to credit
o the influence of government and regulations
The rate of economic growth
An increase in the rate of economic growth (the accelerator effect) signals to firms that the demand for their goods/services is going to increase in the near future. Therefore, firms need to have enough productive capacity to respond to this increase. In order to do this, they will have to increase the amount of money that they invest in capital goods. Firms will be willing to make this invest in order to maximise their future profits.
Business expectations and confidence
If firms believe there will be an increase in the demand for their goods/services in the future then their marginal propensity to invest is likely to increase. This is because they will need to increase their productive capacity in order to meet the increase in demand that is likely to take place in the future. In addition to this, if firms believe that their profit levels will increase, then they will be more confident to use their money for investment purposes. As a result of this, when business confidence is high, investment within the economy increases thus leading to an increase in AD.
Demand for exports
If the demand for exports increases, then so will the demand for domestic goods/services. In order to match this increase in demand, some firms may have to increase their investment in capital goods in order to increase their productive potential, consequently allowing them to meet this demand in the future. In addition to this, the increase in the demand for exports also increases firms’ revenue and most likely profits. This will give firms an increased level of retained profit thus giving them more profit to invest.
Keynes and ‘animal spirits’
The term animal spirits was used by Keynes in order to describe the emotional and instinctive side of humans, thus helping to understand the level of confidence or pessimism conveyed by consumers and firms and why this influences their decision either to save or spend/invest. The term was founded by Keynes during the great depression and links psychological changes in both consumers and firms to the state of spending/investment in the economy. This has had an influence on macroeconomic policy decisions made since the great depression took place. In times of strong economic growth and rising markets, entrepreneurs are willing to take risks as their “animal spirits” are strong. This leads to an increase in Aggregate demand as investment increases. However, when animal spirits are weak, aggregate demand will fall as only strong willed entrepreneurs would be willing to put their money at risk.
Access to credit
The easier the access to loanable funds, the higher the levels of investment. Some developing economies have low access to credit and this holds back investment
The influence of government and regulations
Interest Rates
The majority of investment by businesses is financed through bank loans. A decrease in interest rates allow firms to borrow money at a lower rate than before, as they do not have to pay as much money back on top of the initial loan.
