Aggregate Demand - Investment

Question 1

Investment

Answer 1

Investment: addition to capital stock of the economy e.g. factories,
machines, offices, equipment, stocks of materials used to produce other
goods.
Depreciation (capital consumption): value of the capital stock that falls in
value over time as it wears out or is used up.
Gross investment: investment before depreciation.
Net investment: gross investment – depreciation.
NB Capital investment is not the same as financial investment
Private sector investment: investment undertaken by businesses in the
private sector.
Public sector investment: investment by the government often in
infrastructure (transport, telecommunications, energy networks, new
schools, new hospitals).
Foreign direct investment (FDI): capital investment made by a company
based in one country in another country e.g. Nissan in Sunderland.

Question 2

Factors influencing investment

Answer 2

• Interest rate: lower interest rate reduces the cost of borrowing and
  boosts the attractiveness of investing relative to retaining profit;
  investment will increase.
• Availability of finance: if a firm is borrowing funds to invest, it has to
  access them from financial institutions; if the firm has some of its own
  funds, it will be easier to borrow.
• Demand for the final product: if the demand for a firm’s output
  increases, a firm has a greater incentive to expand to meet the
  demand, driven by potential for more profit.
• Business confidence: if business are confident about their future sales
  they are more likely to invest.
• Corporate taxes: if taxes on companies eg corporation tax or business
  rates, fall, there is more retained profit to use for investment.
• Business regulation: a reduction in red tape and bureaucracy for
  businesses can incentivise more investment.
• Technological change: businesses will invest in new
  technologies/innovations to ensure they do not lag behind their
  competitors.
  (And vice versa for factors causing a fall in investment)

Question 3

Why do firms invest?

Answer 3

To expand their business and increase their output capacity
To reduce average costs of production due to economies of scale
To increase efficiency and productivity through innovation and technological
progress
To meet an increase in market demand and increase market share
To expand a firm’s product range
To replace depreciated capital
To increase competitiveness at home and abroad

Question 4

Impact of investment on AD & AS

Answer 4

Investment adds to aggregate demand AD causing short run growth, lower
unemployment
Successful investment also adds to the economy’s capacity, long run
aggregate supply LRAS; long run non-inflationary growth

Question 5

How investment influences the macroeconomy

Answer 5

• Creates extra demand in investment goods industries
• Injects money into the circular flow of income (multiplier effect)
• Boosts both short run and long run economic growth
• New capital boosts productivity and increases the capacity to supply
• Improves a country’s competitiveness, improving the trade balance
• Improves the economy’s infrastructure to make it more efficient
• Can help create new jobs (though some may be lost to automation/AI)
• Can help reduce inflation pressure