No 187: AS Summary of Investment

DOES exactly what it says on the tin!

Investment as a Part of AD

We studied the component of AD that measures firms’ demand for capital goods, called investment. It forms about 15% of UK AD.

There are a number of factors that influence it, including interest rates, business confidence, depreciation of capital goods, future sales and demand, the expected rate of return, changes in costs, indirect taxes and subsidies, and technological changes in capital goods.

It could be argued that investment is the most important part of AD, since as well as leading to actual economic growth, it can also increase potential economic growth. We can show the former by a shift in the AD curve increasing Real GDP from Y1 to Y2, and the latter by a shift out in the PPF curve.

However, investment is also the most volatile part of AD. This is because businesses quickly cut investment in a downturn, both due to falling profits (reducing money available for investment) and less need to increase productive capacity. On the other hand, in a recovery it increases quickly, due to rising profit and more need to expand production to meet increasing consumer demand.

In summary, this was yet another exciting class on Mr Spottiswoode’s economic course.