CH25 Investment

Question 1

What is investment?

Answer 1

it is the purchase of capital goods which are then used to create other goods and services.

Question 2

What are 2 different types of investment?

Answer 2

Gross and net investment

Question 3

What happens to the value of capital stock over time? And what is this called?

Answer 3

its value depreciates over time as it wears out and is used up. This is called depreciation or capital consumption

Question 4

What is gross investment?

Answer 4

It measures investment before depreciation

Question 5

What are the 2 types of captial?

Answer 5

Human capital and physical capital

Question 6

What is meant by investment in human capital?

Answer 6

investment in human capital is investment in education and training of workers

Question 7

What is meant by investment in physical capital?

Answer 7

investment in factories etc

Question 8

What 2 sectors invest?

Answer 8

investment is made by both private and public sector

Question 9

What are the 8 determinants of private sector investment in physical capital?

Answer 9

-interest rates
-credit provision
-the rate of economic growth
-business expectations and confidence
-costs
-the world economy
-retained profit
-government regulations

Question 10

How do interest rates affect investment?

Answer 10

in two ways:
1) some investment is financed by firms borrowing money from banks or the money markets. Interest paid on a loan is then part of the cost of an investment project. So a rise in the rate of interest will reduce the number of profitable investment projects and so there will be less investment by firms. The opposite is true.
2) some investment is financed by retained profit. The higher the rate of interest that banks and money markets offer on savings, the more attractive it is for firms to save money rather than invest in physical capital. The lower the rate of interest, the greater the incentive for firms to run down their savings and use them to buy investment goods

Question 11

How does the rate of economic growth affect investment?

Answer 11

-if the same products and the same amount is being produced in an economy year after year, the level of investment will remain the same. Firms will invest to replace physical capital, such as the machines that have worn out. But there will be no need to increase investment beyond this replacement level.
-If the economy is expanding, firms will need to increase their investment to have the capital equipment to produce more goods and services.
-if the economy is shrinking in size, as in a recession, firms will not need to replace all their investment goods which have become worn out. With lower output, they will need less capital equipment. So investment will fall when the rate of economic growth is negative

Question 12

What is the accelerator theory?

Answer 12

it is the idea that investment is linked to changes in output or income in the economy

Question 13

What is the formula for the accelerator theory?

Answer 13

It = a (Yt - Yt-1)

Question 14

What does the It stand for?

Answer 14

It is investment in the time period ‘t’

Question 15

What does the Yt - Yt-1 stand for?

Answer 15

it is the change in real income during year t

Question 16

What does the a stand for?

Answer 16

a is called the accelerator coefficient and it is the capital-output ratio

Question 17

What is the capital-output ratio?

Answer 17

it is the amount of capital needed in the economy to produce a given quantity of goods

Question 18

How do costs affect investment?

Answer 18

-firms need to make profit. They have to be able to sell the products made from an investment.
-they also have to keep their costs below the selling price. Increases in costs such as increases in wages or raw materials will reduce the profitability or rate of return on an investment, all other things being equal.

Question 19

How does business expectations and confidence affect investment?

Answer 19

-if firms expect their sales to increase, they are more likely to invest in new capital equipment. In a boom in the economy, for example, investment is likely to rise. However, if firms lose confidence and expect sales to fall in the future, they are likely to cut back on their investment plans

Question 20

What did Keynes mean by the phrase ‘animal spirits’?

Answer 20

he used this phrase to describe the mood of managers and owners of firms

Question 21

How can the world economy affect investment?

Answer 21

is the world economy is booming, demand for exports is likely to increase. This in turn should lead to a rise in domestic investment
-conversely, a worldwide recession will reduce the demand for exports. So exporting firms are likely to cut back their investment. This will have a knock-on effect on other firms in the economy, reducing their sales and reducing their willingness to invest

Question 22

How can access to credit affect investment?

Answer 22

-some investment is financed through borrowing. The amount of money available to borrow within the financial system varies.
-after the financial crisis of 2008, banks became more risk averse, meaning they were less willing to give loans because they feared that firms would not be able to pay the money back with interest. So firms may want to borrow money to buy capital equipment but they may be turned down by banks as being too risky a customer

Question 23

How can retained profit affect investment?

Answer 23

-if firms have the money available then they will invest

Question 24

How can government regulations and influence affect investment?

Answer 24

-cutting tax on profits will increase investment. This is because cutting taxes on profits effectively cuts costs for a firm on its investments. This raises the rate of return or profitability.
-governments can also guarantee loans made by banks to firms for investment. If the firm fails to pay back the money, the gov pays the bank instead. This encourages banks to lend more money, even on higher risk projects.
-highly regulated economies discourage investment. This is because regulation tends to increase costs for firms and so reduces their profitability. Regulation can also directly prevent a firm investing in a project because it is not permitted by regulations.