Macroeconomic Activity

Factors that affect Investment

Contributors
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Carys Brown

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Investment
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Investment is defined as expenditure on producer and capital goods that can be used to produce final goods and services in the future. It is the most volatile element of aggregate expenditure as it swings between 16-23% of GDP. This is because it is money spend on expansion for the future, therefore, it involves a certain element of risk.

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Rate of Interest
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Much like consumption, investment is highly influenced by the level of interest rates set by the Reserve Bank of Australia (RBA.) If the cash/interest rate increases then investment will decrease. Firstly, cash rates present the ‘price of borrowed money’ or how much it will cost to repay borrowed amounts, therefore, if cash rates rise then the portion of income left to spend on investment is decreased. This is an example of opportunity cost as the money paid on interest could have been spend on investment and capital goods. The opposite is true for reduced interest rates as businesses then have more money left to spend on investment.

Topic Menu
Concept of Macroeconomic Activity
Circular Flow of Income Model
Total Spending, Income and Output
Equilibrium, Injections and Leakages
Effects of Injections and Leakages on Income
Components of Aggregate Expenditure
Factors that affect Consumption
Factors that affect Investment
Factors that affect Government Spending and Net Exports

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In response to current events, the expectations of businesses may be influenced by the current economic climate, for example, the level of sales from buyers. If these expectations are positive, then investment will increase to meet the anticipated demand. However, if business expectations are low, the level of investment will fall. not will increase.

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Profitability
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Businesses will use a percentage of the profits from sales to spend on investment and expansion. If the profits made by the firm fall, then so does the money available to spend on investing into the business.

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Government Policies
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Both fiscal policies and monetary policies affect the level of investment in an economy. A subsidy is defined as a sum of money paid by the government to businesses in order to reduce cost of production and maintain a lower price of the commodity. If governments offer subsidies to firms during a period of low economic activity, then investment will rise. Comparatively, governments may enforce taxes on firms, a levy onto certain goods that raises the price of the commodity in order for governments to make revenue. Taxes reduce the level of investment as it potentially may decreases sales and, in turn, take up a larger percentage of the profit.

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