Cambridge International as and a level Economics Ebook

Investment
Investment
is spending by fi rms on capital goods, such 
as factories, offi
ces, machinery and delivery vehicles. 
Th
e amount of investment undertaken is infl uenced 
by changes in consumer demand, the rate of interest, 
technology, the cost of capital goods, expectations and 
government policy.
If consumer demand rises, fi rms are likely to want 
to buy more capital equipment to expand their capacity. 
Similarly, a fall in the rate of interest is likely to stimulate 
a rise in investment. Th
e cost of investment will fall. 
Firms that borrow to buy capital goods will fi nd it 
cheaper and fi rms that use retained profi ts will fi nd that 
the opportunity cost of investment will fall. Firms will 
also expect higher sales as lower interest rates will raise 
consumer demand.
Advances in technology will raise productivity 
of capital goods and so will probably stimulate more 
investment. Similarly, a fall in the price of capital 
equipment and/or cost of installation of capital goods is 
likely to raise investment.
As with consumption, expectations can play a key role 
in determining investment. When fi rms are optimistic that 
economic conditions are improving and demand for their 
products will rise, they will be encouraged to raise their 
investment. Governments can also seek to increase private 
sector investment by cutting corporation tax (the tax on 
company profi ts) and by providing investment subsidies.
Government spending
This covers spending on items such as medicines 
used in state hospitals, equipment used in state 
schools and government investment in new roads. 
Saving function: 
the relationship between income 
and saving.
Average propensity to save: 
the proportion of income 
that is saved.
KEY TERMS