1. THE ROLE AND NATURE OF INVESTMENT

Learning Objectives1. Discuss the components of the investment spending category

of GDP and distinguish between gross and net investment.2. Discuss the relationship between consumption, saving, and

investment, and explain the relationship using the production possibilities model.

1.1 Components of Investment

1.2 Gross and Net Investment

1.3 Volatility of Investment

1.4 Investment, Consumption and Saving

B

A

D

PPC1

IA

PPC2

IDIB

CA

CD

CB

If depreciation equals IA then net investment is zero and PPC does not shift.

If depreciation equals IA then net investment is zero and PPC does not shift.

By reducing consumption and increasing investment the PPC shifts outward.

Allowing more consumption

By reducing consumption and increasing investment the PPC shifts outward.

Allowing more consumption

2. DETERMINANTS OF INVESTMENT

Learning Objectives1. Draw a hypothetical investment demand curve, and

explain what it shows about the relationship between investment and the interest rate.

2. Discuss the factors that can cause an investment demand curve to shift.

2.1 Interest Rates and Investment

• The investment demand curve is a curve that shows the quantity of investment demanded at each interest rate with all other determinant of investment unchanged.

2.2 Other Determinants of Investment Demand

• Expectations• The level of economic activity• The stock of capital• Capacity utilization

– The capacity utilization rate is a measure of the percentage of the capital stock in use.

• The cost of capital goods• Other factor costs• Technological change• Public policy

3. INVESTMENT AND THE ECONOMY

Learning Objectives1. Explain how investment affects aggregate demand.2. Explain how investment affects economic growth.

3.1 Investment and Aggregate Demand

ΔAD=$100ΔI=$50

AD2AD1

ID

$8,100$8,000

DC1.0

6

8A

B

$1,000$950

3.2 Investment and Economic Growth

• Investment adds to the capital stock• An increase in capital stock leads to an outward shift of the

PPC• This allows more consumption • The long run AS curve also shifts to the right• The increase in investment also affects aggregate demand