- Investment is described as the addition of capital stock to the economy.
- It is the third largest component of AD, forming around 14% of it.
Gross investment is the total amount of money invested into an asset, whereas net investment is the amount of invested money minus any depreciation. For instance, the gross investment into a machine may be £25,000, however due to wear and tear, £5000 of depreciation occurs over a year. This would leave the net investment at £20,000 after the year is over.
There are 7 influences on investment:
- The rate of economic growth – in periods of high economic growth, firms will make increased profit from their existing investments. These increased funds can be reinvested, which will lead to a rise in AD.
- Business expectations and confidence – when businesses are confident in a market and have an expectation of high returns, they will invest more in anticipation of profit. This will see an increase in AD.
- Keynes and ‘animal spirits’ – in his book ‘The General Theory of Employment’, British economist John Maynard Keynes used the term ‘animal spirits’ to describe how human instinct and emotion can drive economic decision. This factor can lead to extreme investment, which could lead to a rise or fall in AD.
- Demand for exports – if the need for other countries to import is very high, domestic firms will invest more to produce goods to export.
- Interest rates – if the central bank (Bank of England) increases interest rates, borrowing will become increasingly expensive (and will create an opportunity cost), so investment is decreased. This will cause AD to fall.
- Access to credit – shortly after a large financial crisis, banks may be unwilling to lend, making it more challenging for firms to access credit to invest, decreasing the aggregate demand.
- The influence of government and regulations – these have a strong bearing on AD too. For example, whilst a rise in corporation tax would decrease investment, a drop in the minimum wage would see investment rise.