investment

• Investment is the addition to capital stock used to produce other goods and services, including factories, machinery, offices and stocks of materials.
• Buying shares in a company is saving, not investment, as it is not used to produce more goods and services.
• Buying new machinery to set up a company is an example of investment.
• Net investment refers to gross investment minus depreciation.
• Capital stock depreciates over time as it wears out and is used up, and this is called depreciation or capital consumption.
• Gross investment measures investment before depreciation.
• In recent years, depreciation in the UK has accounted for about three-quarters of gross investment, so only about a quarter of gross investment represents an addition to the capital stock of the economy.
• Investment in physical capital is that in factories or tangible things.
• Human capital investment refers to investment in, for example, education or training.
• Public sector investment is investment by the government and which is subject to complex political considerations.
• Factors affecting investment include interest rates, tax, specifically corporation tax, business confidence, and the world economy.
• Interest rates affect the levels of investment in two ways: some investment is financed by firms borrowing money from banks, so higher interest rates reduce borrowing by making it more expensive, while lower interest rates create a greater incentive for firms to withdraw their savings and buy investment goods.
• Other determinants of investment include costs, confidence, the world economy, access to credit, retained profit and government policy.
• Costs: private sector firms need to make a profit, to sell the products made from an investment, and they also have to keep their costs per unit below the selling price.
• Confidence: if firms expect their sales to increase, they are more likely to invest in new capital equipment, and during a boom in the economy, investment is likely to rise.
• The world economy: if the world economy is booming, demand for exports is likely to increase, which should lead to a rise in domestic investment, but a worldwide recession will reduce the demand for exports, so exporting firms are likely to cut back on investment.
• Firms can also be risk averse, not wanting to borrow money in case the investment fails to make a profit.
• Investment is the injection of demand for capital goods and industries.
• Cutting tax on profits, known as corporate tax, can increase investment as this cuts costs for a firm on its investments, raising the profitability.
• Another way that the government can encourage investment is by guaranteeing that if a firm does not pay a bank back its loan plus interest, the government will pay it for them, leading banks to lend money on higher risk projects.
• Investment can help to sustain export-led growth.
• Government policy: Governments can influence investment across the economy as well as in particular sectors.
• Investment can contribute to economies of scale and better competitiveness.
• Firms may be turned down by banks for being too risky a customer.
• Investment can lift productivity/incomes.
• Some economists argue that firms, particularly small firms, tend not to consider the opportunity cost of investment - the interest lost from lending it out.
• Retained profit: About 70% of industrial and commercial investment in the UK is financed by retained profit, which is the profit kept back by a firm for its own use which is not distributed to shareholders or used to pay taxation.
• The accelerator theory: If the same products and the same amount is being produced in an economy year after year, the level of investment will also remain the same.
• The idea that investment is linked to changes in output or income in the economy is called the accelerator theory, which can be expressed by the equation:
• After the financial crisis in 2008, banks became more risk averse and were less willing to give loans, fearing that firms would not be able to pay the money back with interest.
• An expanding economy will require firms to increase their investment so that they have the capital equipment to produce more goods and services, while firms will not need to replace all of their investment goods in a shrinking economy, as in a recession.
• If money is available, firms will invest, so if retained profit is high they are more likely to invest while low retained profit might deter firms from investing.
• Access to credit: Some investment is financed through borrowing, but the amount of money available for borrowing within the financial system varies.
• Investment is represented by the equation: