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- physical or real investment: capital expenditure on the purchase of assets such as plant, machinery and equipment (FIXED CAPITAL assets) and STOCKS or INVENTORY (WORKING CAPITAL assets). Fixed capital investment is undertaken by firms, both to replace worn-out and obsolete capital items (see DEPRECIATION) and to increase the firm's total assets (see CAPITAL EMPLOYED), so as to enable it to produce a greater volume of products, and, by investing in the latest technology, to remain competitive. In aggregate terms, net additions to the country's CAPITAL STOCK increase the economy's productive capacity, thus making an important contribution to the achievement of higher rates of ECONOMIC GROWTH and improved living standards.
- financial investment: expenditure on the purchase of financial securities such as SHARES and BONDS. PORTFOLIO investment is undertaken by individuals, companies and financial institutions as a means of earning income in the form of dividend, interest and rent payments and through capital appreciation. See CAPITAL ALLOWANCES, ENTERPRISE INVESTMENT SCHEME, ENTERPRISE GRANT SCHEME, STOCK MARKET, FINANCIAL SYSTEM, FOREIGN INVESTMENT, SAVINGS, INVESTMENT INCENTIVE, INVESTMENT APPRAISAL, ACCOUNTING RETURN, PAYBACK METHOD, DISCOUNTED CASH FLOW.
- expenditure on the purchase of FINANCIAL SECURITIES such as STOCKS and SHARES. Also called financial investment. PORTFOLIO investment is undertaken by persons, firms and financial institutions in the expectation of earning a return in the form of INTEREST or DIVIDENDS, or an appreciation in the capital value of the securities.
- capital expenditure on the purchase of physical ASSETS such as plant, machinery and equipment (FIXED INVESTMENT) and STOCKS (INVENTORY INVESTMENT), i.e.physical or real investment. In economic analysis, the term ‘investment’ relates specifically to physical investment. Physical investment creates new assets, thereby adding to the country's productive capacity, whereas financial investment only transfers the ownership of existing assets from one person or institution to another.
Investment can be split up into gross and net investment:
- gross investment is the total amount of investment that is undertaken in an economy over a specified time period (usually one year);
- net investment is gross investment less replacement investment or CAPITAL CONSUMPTION, i.e. investment that is necessary to replace that part of the economy's existing capital stock that is used up in producing this year's output. (See DEPRECIATION 2.)
The amount of fixed investment undertaken is dependent on a number of factors other than capital consumption considerations. In national income analysis, the MARGINAL EFFICIENCY OF CAPITAL/INVESTMENT and the INTEREST RATE are important determinants of the level of investment.
The marginal efficiency of capital/investment itself is dependent upon business confidence and expectations about future demand levels and, therefore, plant utilization. The volatility of business expectations in the short run means that planned levels of fixed investment can vary significantly over time, leading to large changes in the demand for capital goods (see ACCELERATOR), that is, large fluctuations in the investment component of aggregate demand leading to larger fluctuations in output and employment through the MULTIPLIER effect (see BUSINESS CYCLE).
In order to stimulate investment, governments provide tax writeoffs on plant and equipment (see CAPITAL ALLOWANCES for details).
Similar considerations apply to inventory investment, with stock levels being increased or decreased over time with changing business expectations.
The long-term significance of investment lies in the contribution it makes to ECONOMIC GROWTH and economic prosperity. Building new factories, adding new machinery and equipment, and investing in new techniques and products enables industry to supply a greater quantity of more sophisticated products and services to the consuming public, while similar investments in the provision of social capital (schools, health, etc.) contribute vitally to the upgrading of general living standards.
At the micro-level a firm's investment decisions depend upon the profitability or cash flow implications of particular investment projects (see DISCOUNTED CASH FLOW) and are considered as part of its CAPITAL BUDGETING procedures. Compare DISINVESTMENT.
See CAPITAL ACCUMULATION, CAPITAL DEEPENING, CAPITAL GOODS, CAPITAL STOCK, CAPITAL WIDENING, INVESTMENT SCHEDULE, AUTONOMOUS INVESTMENT, INDUCED INVESTMENT, GROSS DOMESTIC-FIXED CAPITAL FORMATION, FOREIGN INVESTMENT, INVESTMENT INCENTIVES, INVESTMENT APPRAISAL, GREENFIELD INVESTMENT, RISK PREMIUM, BUSINESS EXPANSION SCHEME, ENTERPRISE INVESTMENT SCHEME, ENTERPRISE GRANT SCHEME.