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Capital Investment & Spending .docx

4 Pages

Course Code
ECON 1010
Sarrah Vakili

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Capital Investment & Spending The meaning of investment to an economist: Investment to an economist is a precise term which involves the acquisition of capital goods designed to provide us with consumer goods and services in the future. Investment spending involves a decision to postpone consumption and to seek to accumulate capital which can raise the productive potential of an economy. But investment is similar to consumption as it is an important component of aggregate demand. Key Factors Determining Capital Investment Spending Several factors influence how much businesses are prepared to commit to investment projects:  Real interest rates: Interest rates affect the cost of borrowing money to finance investment. If the rate of interest increases, the cost of funding investment increases, reducing the expected rate of return on capital projects. A second factor is that higher interest rates raise the opportunity cost of using profits to finance investment – i.e. a business might decide that the cost of financing new capital is too high and that it could earn a higher rate of return by simply investing the cash. Low interest rates are not always good news for business investment. Recently economists have become concerned that low interest rates has reduced the cost of capital for businesses to such an extent that some low quality capital investment projects have been given the go ahead and much of this investment has proved to be disappointing.  The rate of growth of demand: Investment tends to be stronger when consumer demand is rising, giving businesses an extra incentive to invest to expand their capacity to meet this demand. Higher expected sales also increase potential profits – in other words, the price mechanism should allocate extra funds and factor inputs towards investment goods into those markets where consumer demand is rising.  Corporate taxes: Corporation tax is paid on profits. If the government reduces the rate of corporation tax (or increases investment tax-allowances) there is a greater incentive to invest. Britain has relatively low rates of company taxation compared to other countries inside the EU. This is a factor that helps to explain why Britain has been a favoured venue for inward investment from overseas during the last decade.  Technological change and degree of market competition: In markets where technological change is rapid, companies may have to commit themselves to higher levels of investment to keep pace with the shifting frontier of technology and remain competitive. In markets where there is a premium on a business keeping costs down but at the same time, achieving year on year gains in efficiency and quality of service, there is also an incentive to keep capital investment spending high.  Business confidence: Business confidence can be vital in determining whether to go ahead with an investment project. When confidence is strong then planned investment will rise. The Confederation of British Industry ( publishes a quarterly survey of confidence that gives economists an insight into likely trends in investment from manufacturing industry – although it must be remembered that ov
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