2.2.3 - Investment (I) Flashcards
What is Investment?
Expenditure by firms on capital equipment
What is ‘Gross Domestic Fixed Capital Formation’?
It is another term for investment, referring to any addition to the capital stock of the economy.
What does a wider definition of investment include?
Any expenditure by firms designed to increase their productive capacity.
What is ‘investment in human capital’?
Expenditure on education and training.
Why is investment in human capital important?
More skilled workers will be more productive workers, increasing the productive capacity of firms and the economy.
What does Investment in Research and Development (R&D) refer to?
Expenditure on the development of new products and new methods of production
How do more efficient production techniques affect firms?
They allow firms to produce more with limited resources, increasing productive capacity
What is the relationship between the interest rate and the level of investment?
Inverse, or negative
What happens to investment when the interest rate rises?
Investment will fall
What happens to investment when the interest rate falls?
Investment will rise
List one reason why investment falls when the interest rate rises.
- Cost of borrowing increases
- Fewer investment projects yield a return greater than the interest rate
- Opportunity cost of using retained profits for investment increases
What is the impact of higher interest rates on borrowing?
The cost of borrowing increases
How do higher interest rates affect the profitability of investments?
They reduce the profitability of any investment
What do firms prefer to do when interest rates rise?
Save their money instead of undertaking investment projects
Fill in the blank: When the interest rate rises, the opportunity cost of using retained profits for investment projects _______.
increases
How does a fall in Consumption due to higher Interest rates affect Investment?
Firms will expect demand for their products to fall if interest rates go up. Therefore, there is no point investing in increased productive capacity if any extra output is unlikely to be sold. Therefore Investment will fall
How does business optimism affect investment?
If firms are optimistic, they invest more to meet expected demand increases
Conversely, pessimism leads to reduced investment.
What is the effect of rising costs of capital goods on investment?
Investment will fall
Higher costs reduce the profitability of investments.
What happens to investment when capital goods become cheaper?
Investment will rise
Cheaper capital goods increase the profitability of investments.
How do competitive pressures influence investment decisions?
Existing firms may invest more to develop better products at lower costs
This is to retain market position amidst competition.
What percentage of investment is financed from firms’ retained profits?
About 70%
This highlights the importance of profitability for investment decisions.
What is the relationship between rising profits and investment?
If profits rise, investment is likely to rise
Increased profitability motivates firms to invest.
What is corporation tax?
A tax on firms’ profits
It affects the amount of profit available for reinvestment.
What happens to investment if the government cuts corporation tax?
Investment rises
Firms have more profit after tax, providing more funds for investment.
What effect does a cut in corporation tax have on investment?
It makes any investment more profitable for firms, leading to increased incentives to invest.
How can the government encourage investment through subsidies?
By giving grants to firms to cover costs such as research and development.
What is an alternative to subsidies that the government can provide to encourage investment?
Tax breaks for firms, such as not charging tax on profits retained for investment purposes.
What impact does technological change have on firms’ investment decisions?
Firms are likely to invest in new technology that increases productivity and reduces production costs.
What is a key factor in determining investment levels?
The rate of economic growth.
How do improvements in the rate of economic growth affect investment?
They tend to increase investment.
What types of demand are important for determining investment?
Demand from overseas and demand for exports.
Fill in the blank: A cut in corporation tax means firms keep more of their _______.
[profits]
True or False: Government subsidies can only be in the form of cash grants.
False
Fill in the blank: Firms are likely to invest in new technology if it is likely to increase _______ and reduce costs.
[productivity]
