1. Consumption, savings and investment
SBC Economics
Consumption, savings and investment
Learning outcome X
Define, consumption, savings and investment
Explain the determinants of consumption, saving and investment
Explain the difference between gross and net investment
Reading: Units 31 & 32

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

3. Gross and net investment
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

4. Marginal efficiency of capital
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

5. Planned investment schedule

6. Marginal efficiency of capital and interest rates
It can be seen from the diagram that:
An increase in interest rates will lead to a decrease in investment
A decrease in interest rates will lead to an increase in investment

7. Shifts in planned investment
Rate of
interest I3 I1 I2 O
Planned investment

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

9. What causes the planned investment schedule to shift?
Technological change
Technological change makes capital equipment more productive and so the rate of return on investments will rise
Technological improvements will therefore lead to increased investment and the investment schedule will shift outwards (to the right)

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

11. What causes the planned investment schedule to shift?
Government policy
Governments make decisions regarding the business environment, these decisions will effect the willingness of firms to make investments
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

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