4- Investment Flashcards
Investment definition
The spending of money on capital goods by firms in order to increase their productive possibility.
Gross investment definition
The total investment on the new capital inputs.
It’s the total amount that the economy spends on new capital.
Net investment definition
Gross investment taking into account the depreciation of capital. (gross investment - capital depreciation)
Relationship between investment and jobs
- Some investment projects cost people’s jobs when a business replaces labour with capital inputs.
- Investment creates jobs in producing, designing and installing plants and equipment.
The importance of quality investment
- A high level of investment on its own may not be sufficient to create an increase in LRAS since workers need training to work the new machinery and there will be time lags between capital spending and the effects on output and productivity.
- If there is insufficient demand, a growing capital stock may lead to excess capacity putting downward pressure on prices and profits.
Key factors affecting capital investment spending?
- Interest rates
- Risk
- The rate of growth of market demand
- Corporate taxes
- Technological change and degree of market competition
- Business confidence
- Social costs and benefits
How does interest rates affect investment?
- Interest rates affect the cost of capital
- If the rate of interest increases, the cost of funding investment increases , lowering the rate of return on a capital project.
- Higher interest rates also raise the opportunity cost of using profits to finance investment- i.e. a business might decide that they can earn a better return by simply investment.
How does risk affect investment?
Committing money to a project involves taking a risk for no business can be certain that a given project will succeed and bring about a profit. When risk and uncertainty is high for example during times of volatility then business investment spending may fall.
How does the rate of growth of market demand affect investment?
Investment tends to be stronger when consumer spending is rising. Higher expected sales also increase potential profits- in other words, the price mechanism should allocate extra funds and factor input towards capital goods into these markets where consumer demand is rising.
How do corporate taxes affect investment?
- Corporate tax is paid depending on the level of business profit. If the government reduce the rate of corporation tax there is greater incentive to invest.
- The main rate of corporation tax was reduced from 28% in 2010 to 21% in 2015, then it will increase after 2021 budget.
- The government may also change the level of tax allowances e.g. the incentives for businesses to offset their investment spending against future tax bills.
- Regulations can also affect planned investment. For example, laws on carbon emissions might affect innovation and investment in the transport industry by businesses looking to cut their emissions and make significant progress towards low carbon production.
How does technological change and degree of market competition affect investment?
In markets where technological change is rapid, companies may have to invest simply to remain competitive. A good example is the intense competition in the market for smartphones.
How does business confidence affect investment?
During a downturn many businesses may postpone investment because they feel that demand will not be high enough to give them the rate of profit they need. The Keynesian term for business confidence is animal spirits.
How does social costs and benefits affect investment?
In the public (government) sector, a different sea of criteria may be used. Typically, local and central government will use cost-benefit analysis when assessing the likely economic and social effects of investment; this is often used for infrastructure projects.
