Investment

Definition

Investment refers to the purchase of goods that will be used to produce other goods and services in the future, essentially putting money into something with the expectation of generating profit. It plays a crucial role in driving economic growth, as it increases productive capacity and stimulates demand. Understanding how investment functions within financial markets, public policy, and international economics is essential for grasping broader economic concepts.

5 Must Know Facts For Your Next Test

1. Investment is a key component of GDP, often broken down into business investment, residential investment, and inventory investment.
2. Higher interest rates typically lead to lower levels of investment because borrowing costs increase, making it less attractive for businesses to finance new projects.
3. Public policy initiatives, like tax incentives or subsidies for certain industries, can significantly boost levels of investment in an economy.
4. Foreign direct investment (FDI) occurs when a company invests directly in facilities to produce or market a product in a foreign country, influencing the balance of payments.
5. Investment can take various forms including physical assets (like machinery), financial assets (like stocks), and human capital (like education and training).

Review Questions

• How does the loanable funds market influence levels of investment in an economy?
  • The loanable funds market is where savers supply funds for loans to borrowers who want to invest. When there is an increase in savings, it leads to a greater supply of loanable funds, which can lower interest rates. Lower interest rates make borrowing cheaper for businesses and individuals, encouraging them to invest more. Thus, changes in the loanable funds market can directly affect the overall level of investment in an economy.
• Evaluate the impact of public policy on investment decisions made by businesses.
  • Public policy plays a significant role in shaping business investment decisions. For example, tax incentives can make certain investments more appealing by increasing potential returns. Additionally, government spending on infrastructure can create demand for new business investments as companies anticipate increased sales. Conversely, uncertainty due to policy changes can lead businesses to delay or reduce their investment plans, illustrating the critical interplay between public policy and private investment behavior.
• Analyze how changes in foreign direct investment impact a country's balance of payments accounts.
  • Foreign direct investment (FDI) affects a country's balance of payments by contributing to both the capital account and the current account. When foreign companies invest in domestic firms or establish new operations, it results in capital inflows that positively impact the capital account. However, if these foreign investments lead to profits being repatriated back to the home country, it can result in outflows that negatively affect the current account. Understanding this relationship is vital for assessing how FDI can influence a country's overall economic stability and growth prospects.

Related terms

Capital Goods: Physical assets such as machinery, buildings, and equipment that are used in the production of goods and services.

Gross Domestic Product (GDP):

A measure of the economic performance of a country, representing the total dollar value of all goods and services produced over a specific time period.

Interest Rates: The cost of borrowing money or the return on savings, which influences the level of investment in an economy.