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Lesson 15: Factors Which Affect Investment (I)

Module 1: Macro Fundamental Analysis

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Video Transcript

In this lesson we’re going to look at the investment tab here of this spreadsheet now this is the i component of real GDP or aggregate demand in this case so c plus i plus g plus nx is aggregate demand and that equals real GDP and when we’re looking at investment we’re looking at the marginal propensity to invest so mpi the willingness to invest each additional unit of income this is what drives demand so an increase in mpi drives demand a decrease in mpi sees a decline in demand so when we’re talking about investment here we are specifically talking about the business segment of the economy out of those three pillars of the economy and investment is defined as capital goods expenditure so money which is spent on capital goods by businesses so the key factors which affect investment in an economy are changes in retained profits so income minus taxes this is very similar to what we just looked at in terms of consumption with the consumer so but instead of personal income you’re looking at income for a business so profits for a business so an increase or decrease in corporation tax is going to see an increase or decrease in the marginal propensity to invest because if there is an increase in corporation taxes then there has been a decrease in retained profit or revenue or profits net profit for businesses and therefore they will have less money to go out and spend and the mpi their willingness to invest each additional unit of income will decrease and with that so too will demand so there’ll be a decline in the i input of the real GDP formula and GDP as a result will decline as well if there is a cut to corporation taxes this will see an increase in retained profit in net profits for businesses the mpi will increase so the willingness to invest each additional unit of income will increase as businesses make more in retained profits so an increase or decrease in income which is essentially exactly what we looked at it was more a derivative of what we just looked at because we looked at a cut in say corporation tax increases income but there are other ways that income can be affected let’s say wages go down which starts to shift the short run aggregate supply curve to the right so those costs of production start to decline you get srs shifting to the right you get greater levels of output and economic growth and that would increase so a decrease in wages would increase the marginal propensity to invest because corporations would retain more profits you could have subsidies so if a government issues a subsidy to a company there will be a greater marginal propensity to invest because they will be retaining more profits because money used from the subsidy will be money saved in their own income you could have a grant a business which is given a grant this would essentially be a boost for income and conversely if wages were to go up like we discussed in the previous tab this could actually start to shift sras to the left you could see a reduction in supply and a reduction in GDP and this would be because the marginal propensity to invest each additional unit of income would actually decrease and we would see a contraction in GDP capacity utilization is also an indication of the marginal propensity to invest so how much spare capacity does the economy have or do businesses have if businesses are operating near maximum capacity they are going to be much more motivated to go out and spend and invest because they will be making more money if a business is only running at say 60 capacity because the demand is not there this is in and of itself going to reduce the marginal propensity to invest so there will be less of a willingness for business to go out and spend if they’re not operating at full capacity if there’s lots of spare capacity in the economy competition also drives the marginal propensity to invest so if there is a high amount of competition in any given sector or industry or economy as a whole there is more of an incentive to go out and invest because businesses are trying to compete they’re trying to get an edge over their competitors so they’re more likely to go out and actually spend to try and create that advantage and actually win business than if they were say a monopoly which by definition means there is no competition in which case why bother go out and spending lots of money in investing if you pretty much have the market cornered anyway so a lack of competition would actually see a decrease in the marginal propensity to invest and this is why monopolies generally speaking are actually quite bad for the economy and this is why we also have in many economies laws against anti-competitive behavior so we also have business confidence now an increase or decrease in expected demand so if businesses are expecting high amounts of demand they may go out and spend more so say there is a certain time of the year Christmas is coming up for example and businesses expect a huge amount of demand coming over the Christmas season they’re more likely to actually go out and invest in maybe advertising and anything else that they need to invest in in order to get to that business and in order to actually meet that increase in inspected demand if they expect demand to decrease for example for whatever reason they will be less likely to go out and invest if they think the demand isn’t going to be there and an increase or decrease in future profits as well now these two again are very very intimately linked although they’re not exactly the same because you could have the same level of demand but actually make more or less money depending on a number of other variables but equally if you expect there to be demand in an economy you would logically expect to generate higher profits with higher demand so those two things again are separate but they are inextricably linked and they do more or less go hand in hand so an increase in business confidence an increase in the marginal propensity to invest an increase in demand on the investment side and therefore an increase in real GDP a decrease in business confidence a decrease in the marginal propensity to invest and a decrease therefore in demand overall in the economy and also this will have a negative impact on GDP on real GDP and finally down the bottom here we have credit exactly the same as for the consumer businesses also need to either take credits to go out and invest or invest from the profits they already have so if interest rates are to go up this is an incentive to actually save money and it’s a disincentive to borrow money because you have high repayments if interest rates are cut this is a disincentive to save so businesses are more likely to go out and access credit in order to invest if they know that they have very low interest rates so it’s an incentive to borrow money to invest and of course credit availability as always the second part of that is the access to credit that businesses may have if the banks are not willing to lend to businesses it doesn’t matter how much incentive they have to take the credit there will not be an increase in demand because they will not be accessing the credits and vice versa if they can very easily obtain credits and banks are very willing to lend then this is going to have an impact on investment in the total demand of the economy it will increase this so a positive impact on investment which will in turn have a positive impact on real GDP so all of these factors play a key role in the increase or decrease in investment and then as a result also increases and decreases in real GDP