Consumption savings and investment Learning outcome X n

Consumption, savings and investment Learning outcome X n Define, consumption, savings and investment n Explain the determinants of consumption, saving and investment n Explain the difference between gross and net investment Reading: Units 31 & 32 A Leader in International Education in China

Investment Additions to the capital stock of the economy i. e. factories, machines, offices etc.

Gross and net investment n n There is a difference between gross and net investment Capital stock depreciates over time this is known as depreciation (or capital consumption) Gross investment measures investment before depreciation Net investment measures investment after depreciation A Leader in International Education in China

Marginal efficiency of capital n n n Firms invest in order to make a profit (a return on their capital) The rate of return on an investment is the marginal efficiency of capital (MEC) How much investment there is in an economy depends on the interest rate as firms will only invest in projects that yield a higher rate of return than the interest rate A Leader in International Education in China

Planned investment schedule

Marginal efficiency of capital and interest rates It can be seen from the diagram that: n An increase in interest rates will lead to a decrease in investment n A decrease in interest rates will lead to an increase in investment A Leader in International Education in China

Shifts in planned investment Rate of interest I 2 O I 1 I 3 Planned investment

What causes the planned investment schedule to shift? Cost of capital goods n If the cost of capital goods rises then the rate of return of investments will fall n Increases in the cost of capital goods will therefore lead to reduced investment and the investment schedule will shift inwards (to the left) A Leader in International Education in China

What causes the planned investment schedule to shift? Technological change n Technological change makes capital equipment more productive and so the rate of return on investments will rise n Technological improvements will therefore lead to increased investment and the investment schedule will shift outwards (to the right) A Leader in International Education in China

What causes the planned investment schedule to shift? Expectations n Managers in part base their estimates of the rate of return on their expectations of the future n A positive view of the future will therefore lead to increased investment and the investment schedule will shift outwards (to the right) n A negative view of the future will therefore lead to decreased investment and the investment schedule will shift inwards (to the left) A Leader in International Education in China

What causes the planned investment schedule to shift? Government policy n Governments make decisions regarding the business environment, these decisions will effect the willingness of firms to make investments n Government policy that is helpful to business will encourage greater investment and the investment schedule will shift outwards (to the right) Unit 38 gives more detail regarding government policies A Leader in International Education in China

The accelerator theory Accelerator theory n The accelerator theory suggests that planned investment depends on the rate of change in real output n If real output is growing then firms need more capital equipment and so investment increases n If real output decreases then firms current level of capital equipment is sufficient and so investment decreases n Therefore in periods of rapid economic growth investment will grow quickly (accelerate), in periods of economic slowdown investment will decrease quickly (decelerate) A Leader in International Education in China