Determinants of Investment

Investment is a crucial component of the aggregate demand equation. Changes in investment levels can cause shifts in aggregate demand.

Definition of Investment in Economics

• Investment: In economics, investment refers to firms spending money on capital goods to increase their productive capacity.

Factors Influencing Investment

Interest Rates

• Financing Investment: Firms finance investment either by borrowing money or using retained profits.
• Impact of Interest Rates:
  • Low Interest Rates:
    • Lower cost of borrowing.
    • Greater incentive for firms to borrow and invest.
    • Easier to achieve the required rate of return (hurdle).
    • Increases marginal propensity to invest.
  • High Interest Rates:
    • Higher cost of borrowing.
    • Decreases investment.
    • Shifts aggregate demand to the left.

Business Confidence

• Determinants:
  • Expectation of future profits.
  • Expectation of future demand.
• Impact:
  • High Business Confidence:
    • Increased investment to meet expected future demand.
    • Higher marginal propensity to invest.
  • Low Business Confidence:
    • Lower investment due to expected low profit and demand.

Corporation Tax

• Retained Profit:
  • Profit left after paying corporation tax.
• Impact of Corporation Tax:
  • Low Tax:
    • Higher retained profit.
    • More funds available for investment.
  • High Tax:
    • Lower retained profit.
    • Less investment.

Spare Capacity

• High Spare Capacity:
  • Less need for additional investment.
  • Less marginal propensity to invest.
• Low Spare Capacity:
  • Incentive to invest to increase capacity.

Level of Competition

• High Competition:
  • Encourages investment to improve or match technology.
  • Investment in capital, R&D, and technology to stay ahead of rivals.

Price of Capital Machinery

• Low Price:
  • Reduces cost of investment.
  • Increases marginal propensity to invest.

Accelerator Effect

• Definition:
  • Increasing rate of real GDP encourages more investment.
  • Positive feedback loop where investment increases GDP, which further encourages investment.

Stay tuned for the next lecture on government spending.