Investment (I) (Edexcel A Level Economics A)

Gross & Net Investment

• Investment is the total spending on capital goods by firms

  • Investment helps to increase the capacity (production possibilities) of an economy 

  • Increased capacity = increased potential economic growth

• Depreciation is the decrease in monetary value of a capital good (asset) over time

  • Replacing old capital goods does not necessarily increase capacity

    • It can, if the replacement technology means an increase in capacity is possible

• A distinction can be drawn between gross and net investment

  • Gross investment is the total amount of spending on capital goods

    • This spending includes replacing old capital goods and purchasing new capital goods

  • Net investment is the gross investment - depreciation

    • This metric provides information on the addition of new capital goods to an economy

    • It gives a better indication of the extra production possibilities that have been created through investment by firms

Influences on Investment

• Investment by firms is influenced by multiple factors in an economy

• Firms will choose to invest if they feel confident that they will make a good return on their investment

  • The decision to invest is linked to the business objective of profit maximisation

A Table That Shows Four Key Influences on the Decision by Firms To Invest

Other Influences on Investment

• In addition to the points above, the following three influences also influence investment decisions by firms:

1. Business expectations and confidence: the longer a period of economic growth, the higher the business confidence will be. If growth slows, future expectations of profits will decrease, and investment decisions will become harder

2. Keynes and animal spirits: John Maynard Keynes believed firms exhibit too much optimism in the good times and take too many risks. They run with the mood of the economy and make less rational investment decisions as they follow the herd

3. Access to credit: The easier the access to loanable funds, the higher the levels of investment. Some developing economies have low access to credit and this holds back investment