1. Investment in the Private Sector

3. Learning outcomes By studying this section students will be able to: –define and distinguish between different types of investment –analyse the factors which affect an investment decision –analyse the effects of investment on the economy

4. Definition Investment may be defined as expenditure on capital goods and working capital. – Fixed capital goods consist of buildings, plant and machinery. – Working capital consists of stocks of raw materials, semi-manufactured goods and manufactured goods which have not yet been sold. –Net investment = gross investment – depreciation

5. Factors affecting investment Investment in the private sector is undertaken to increase profitability. Organizations will seek to invest in those projects which yield the highest return. The profitability of an investment project can be analysed by investigating its costs and revenue.

6. Cost of investment planning costs costs of capital goods cost of financing investment running costs of the investment

7. Revenue from investment price of output quantity of output sold other factors

8. Revenue Factors Strong demand from tourists causes new investment in accommodtaion in Koh Phi Phi, Thailand

9. Appraisal techniques payback method net present value internal rate of return

10. The accelerator principle Investment activity in economies tends to be volatile. –When demand for consumer goods and services is relatively stable in an economy, much of the demand for capital goods will take the form of replacing worn-out plant and machinery.

11. The accelerator principle (cont.) Investment activity in economies tends to be volatile. –However, if demand for final goods rises and there is no spare capacity in an industry, then new machinery will have to be purchased. Thus the demand for capital goods will significantly increase to include new machines as well as replacement machines.

12. The accelerator principle (cont.) Investment activity in economies tends to be volatile. –Similarly, if the demand for final goods in an economy falls, firms will find they have over- capacity and too many machines. They will reduce the stock of machines to the new lower levels needed by not replacing worn out machines, so the demand for capital goods will fall.

13. Risk and sensitivity analysis Sensitivity analysis is a technique for incorporating risk assessment in investment appraisal. It works by highlighting the key assumptions upon which investment appraisal figures were based. Sensitivity analysis would calculate the effects on an investment appraisal of changes in these assumptions. It illustrates a project’s sensitivity to a variety of scenarios.

14. Sources of funds retained profits new share issues loans government assistance

15. Investment Conditions

16. Investment in the public sector

18. Learning outcomes By studying this section students will be able to: –identify the sources of public sector investment –identify different types of public sector investment –describe different methods of public sector investment –identify sources of funds for public sector investment

19. Sources National level –government channels leisure and tourism investment through public corporations, quangos such as Sports Councils and government departments Local government Supranational level – e.g. the EU

20. Types Buildings and land – E.g. parks, leisure centres and museums. Plant and machinery – E.g. playground apparatus, computerized booking systems and canal lock equipment. Infrastructure – E.g. roads, railways and airports, water and sewerage, power and telecommunications. Research and development

21. Methods and aims Methods –projects which are wholly public sector- financed –projects which are jointly financed by the public and private sectors –private sector investments which are eligible for public sector investment incentive grants.

22. Methods and aims Aims –provision of goods and services which have significant public benefits, but which might not be profitable enough to attract private sector investment. –economic development or regeneration of a particular area.

23. Public-funded restoration projects on the island of Chios, Greece. Aims –Preservation of cultural capital –Economic regeneration –Provision of jobs

24. Investment appraisal Cf private sector Cost–benefit analysis –all the costs and benefits of a project are identified and weighed up, including social as well as private ones.

25. Cost / benefits of canal restoration

26. Investment incentives Governments offer incentives to encourage investment particularly: –in areas of high unemployment –where there are clear social benefits offered by a scheme –where structural changes in the economy have led to geographic areas of economic decline (for example, rural decline etc.) Incentives can include –tax relief –subsidised loans

27. Sources of funds Sources of funds for public investment include: – operating profits – taxation – borrowing – national lotteries – Public Private Partnerships (PPPs)

28. Sydney Opera House The first estimates for the costs of the Sydney Opera House were $7 million. An appeal fund raised about $900,000 The rest of the $102 million that the Opera House ended up costing came from the profits of a series of lotteries. (Top photo courtesy of Sydney Opera House)

29. The public sector investment debate: Cons The public sector is not a good interpreter of people’s wants. The public sector is not good at ensuring efficient use of funds and tends to allow waste. Public sector investment causes an increase in taxation or public borrowing.

30. Opportunity Cost of Public Sector Investment An increase in public sector investment means either –A reduction of other expenditure (BC) –Or an increase in taxes (YZ)

31. The public sector investment debate: Pros There is insufficient incentive for the private sector to invest in public goods. The private sector under invests in goods which have mainly social benefits. The private sector may not be able to undertake the finance or risk for very large projects. Public sector investment can help regenerate parts of the economy which have suffered from restructuring. Public sector investments can generate jobs when unemployment is high.

32. Investment in the public sector: The End

33. In-class group assignment: Aircraft Demand The demand for new aircraft is very volatile and explained by reference to the accelerator principle What are current demand conditions for new aircraft?