2.2.3 Investment (I) Flashcards
Investment
spending on capital goods such as new factories , machinery & vehicles
Examples of capital investment
Robotics
Integrated plant
Machine tools
Infrastructure
Software
Logistics
What are the 2 types of investment?
Infrastructure- telecommunication networks, ports, sewers, wind farms, roads
Human capital- training, education
Gross investment
spending is the total amount that the economy spends on new capital . This figure includes an estimate for the value of capital depreciation since some investment is needed each year just to replace technologically obsolete or worn - out plant and machinery
Net investment
Net investment = gross investment - capital depreciation
What happens if gross investment is higher than depreciation?
If gross investment is higher than depreciation , then net investment will be positive and this means that businesses will have a higher productive capacity and can meet a higher level of AD in the future .
Capital depreciation
refers to the decline in value of a capital asset
How can depreciation occur ?
Machine wears out
Obsolescence
Resale value falls
Change in demand
The accelerator theory
The accelerator theory suggests that the level of investment varies with the rate of change of income ( or output ) rather than interest rates. The accelerator effect is a positive relationship between planned capital investment and the rate of change of national income In this theory, investment takes place in response to a change in real spending in the economy and changes in spending lead to bigger changes in investment.
Example of the accelerator effect
Consider an industry (sector) where demand is rising rapidly. Initially, firms may respond by intensively using their existing capacity or reducing their stock of finished products. If they anticipate sustained high demand, they may invest in expanding their plant and machinery, factories, and new technology to increase their supply capacity. This leads to a positive accelerator effect: a rise in demand for consumer goods and services causes a larger percentage change in demand for capital goods.
Factors which limit the accelerator theory
Expectations may vary
Time lags
Existing excess capacity
Capital goods industry may not be able to meet new demand
How does the rate of economic growth influence investment?
In a growing economy , businesses invest more confidently due to higher demand and better returns . For example , buying a new machine increases production , but in a declining economy , low demand reduces returns . A growing economy also requires increased investment to meet rising demand , while in a stagnant or shrinking economy , investment remains steady or declines as firms only replace old equipment when necessary .
How does business expectations and confidence influence investment?
The longer a period of economic growth , the higher the business confidence will be . If growth slows , future expectations of profits will decrease , and investment decisions will become harder .
How did Keyne’s theory of animal spirits influence investment?
John Maynard Keynes believed firms exhibit too much optimism in the good times and take too many risks . They run with the mood of the economy and make less rational investment decisions as they follow the herd .
Animal spirits
Animal spirits refers to a mix of confidence , trust , mood and expectations . It was coined by John Maynard Keynes .
How does demand for exports influence investment?
If the world economy is booming , demand for exports is likely to increase and therefore exporting firms ‘ investment is likely to increase to cope with this extra demand . This will have a knock - on effect and encourage other firms to increase their investment .
How do interest rates influence investment?
Most investment involves borrowing , and high interest rates make borrowing more expensive , requiring businesses to expect higher profits to cover costs . Investment can also come from retained profits or savings , but higher interest rates increase the opportunity cost of using these funds . Keynes ‘ Marginal Efficiency of Capital ( MEC ) graph shows that higher interest rates reduce investment , as firms need an expected return at least equal to the interest rate - e.g . , a 10 % rate requires a 10 % return .
How does access to credit influence investment?
Investment will be lower when an investment has a high risk attached to it , as it means there will be less access to credit and interest rates will be higher . In recessions , it is usually more difficult to access credit as risks are higher and banks become more risk aware , fearing firms will not be able to pay the money back .
How does the influence of government and regulations influence investment?
Governments can encourage investment by their own policy decisions . For example , they could offer tax breaks or grants to businesses to try and encourage them to invest . Regulations also affects investment as a highly regulated economy tends to see less investment as regulation increases the cost and time taken to invest , such as planning regulations .
Access to credit
The willingness and ability of financial institutions to lend funds to producers and consumers
Keynesian economics
The economics of John Maynard Keynes . The belief that the state can directly stimulate demand in a stagnating economy . For instance , by borrowing money to fund public works projects like new roads , housing . schools and hospitals
Replacement investment
The purchase of capital goods by firms to replace existing , worn out capital . It does not add to the total capital stock of an economy .
Keynes’ Marginal Efficiency of Capital (MEC)
the net rate of return that is expected from the purchase of additional capital; it is compared to the interest rate
