2.2.3 Investment (Edexcel)

This Edexcel study note covers Investment

a) Distinction Between Gross and Net Investment:

• Gross Investment: Gross investment refers to the total value of all new physical capital (machinery, equipment, buildings) that is produced or purchased within an economy over a specific time period. It includes both replacement investment (to maintain existing capital) and net investment (to increase the capital stock).
• Net Investment: Net investment is the portion of gross investment that represents an increase in the capital stock. It is calculated by subtracting depreciation (the wear and tear on existing capital) from gross investment.

Real-World Example: If a company spends $100,000 on new machinery (gross investment) but $20,000 of their existing machinery wears out (depreciation), their net investment is $80,000.

b) Influences on Investment:

i. Rate of Economic Growth:

• When the economy is growing at a healthy rate, businesses are more likely to invest in new capital to meet increased demand.
• Conversely, during economic downturns, investment tends to decline.

ii. Business Expectations and Confidence:

• Positive expectations about future economic conditions and business prospects encourage investment.
• High confidence in the economy can lead to increased capital expenditures.

iii. Keynes and 'Animal Spirits':

• John Maynard Keynes coined the term "animal spirits" to describe the emotional factors influencing investment decisions.
• Confidence, optimism, and entrepreneurial spirit can drive investment even when rational analysis might suggest caution.

iv. Demand for Exports:

• Strong demand for a country's exports can boost investment, especially in export-oriented industries.
• For example, if foreign demand for a country's automobiles is high, domestic auto manufacturers may invest in expanding production.

v. Interest Rates:

• Low interest rates can reduce the cost of borrowing for businesses, making investment projects more attractive.
• Higher interest rates can discourage investment due to increased borrowing costs.

vi. Access to Credit:

• The availability of credit, including loans and lines of credit, can impact a firm's ability to finance investment projects.
• During credit crunches, businesses may face difficulty obtaining funds for investment.

vii. Influence of Government and Regulations:

• Government policies, such as tax incentives and subsidies for investment, can encourage businesses to invest.
• Regulations can affect the ease of doing business and the attractiveness of investment.

Real-World Example: During the 2008 financial crisis, businesses faced difficulty accessing credit due to a frozen credit market. This lack of credit availability contributed to a significant drop in investment in various sectors.

These study notes should provide a comprehensive understanding of the distinction between gross and net investment and the various factors that influence investment decisions in the context of macroeconomics.