Monday, 6 June 2011

Aggregate Demand - Investment (Macroeconomics)

Right, investment is another of the components that makes up aggregate demand as a whole. It is often referred to as just (I). It basically takes into account firms investing money into their business, which normally occurs when they expect that return of their investment to be larger than the investment itself - or more basically put if there is profit available to be made.

There are many influences on this factor, it is also the most volatile component and therefore fluctuates a lot depending on the economic climate and other factors. Here are the influences:

  • Corporation Tax - This plays a major part in how much investment is made. Corporation tax is a tax on business' profits. So, the lower the tax the more likely firms are to invest as they will be likely to keep a larger percentage of the profit created from the investment. 
  • Interest Rates - This is also a large influencing factor. Interest rates generally dictate the amount paid back on loans. So if the interest rates are low then firms can expect to take out a loan without having to pay as much back in comparison to if interest rates were high. This would be an incentive for firms to increase their investment. Obviously, if interest rates were higher then firms would be discouraged from investing as much.
  • Price of Capital Equipment - Investment is all about firms spending money on capital equipment to expand their output. If the capital equipment is cheap, then firms are more likely to invest in it knowing that they will be able to increase profits potentially at a lower cost. 
  • Profit Levels - This may influence a firms willingness to invest. If a firm has a high profit level already, they will feel more comfortable investing as they have more money to throw around. However if profit levels are very low then the firm will be taking more of a risk investing money and may be discouraged from doing so.

These are the main factors that influence the level of investment in an economy. Other minor factors include changes in real disposable income, expectations and advances in technology. 

That's the lowdown on investment.. Next up will be government spending. Thanks for reading. 

1 comment:

  1. Hey sam,
    i was wondering if you could post answers and conclusions for these 2 questions please.

    How does an increase in interest rates affect aggregate demand? Briefly discuss how each component of aggregate demand is affected?

    Explain the effect an open market has on the equilibrium interest rate?