702 Investment

General-InvestmentComing in at second place, a country’s investment spending contributes to the economy’s growth as well. Why so? In more realistic and modern terms, when venture capitalists and entrepreneurs pump money into a certain business or project, it creates jobs for people, resulting in income/output. I mentioned realistic and modern terms because in some textbooks, they give an example of investment that goes like this: a farmer that chooses not to consume his wheat can invest it by planting it in the next harvesting season to grow even more wheat. That is the fundamental concept of investment, taking the fruits of your labor and putting it back into the production line to create more fruits. But that’s a freakin’ confusing way of looking at it. Here at Quickienomics, we believe in simplicity which leads to better understanding.

For your general knowledge, investment in macroeconomic theory refers to:

  • Non-Residential Investment: Firms buying machines for production
  • Residential Investment: Households buying houses or property for speculative purposes
  • Inventory Investment: Firms NOT SELLING some of their remaining stock to sell in the future (Inflation leads to higher earnings for them)

Okay, I know that there are some of you investment savvy people going like, “Hey, where the hell are the stocks, shares, bonds, options, futures, commodities, etc??????” Chill, that will be covered in the Liquid Assets market and they will all be termed under BONDS. So we will get to that later.

Similarly to consumption, there will be a certain amount of investment that had to made no matter what income the firm or household is earning. That’s called autonomous investment. No matter what, people have to live in houses right? No matter what, firms will need a certain number of machines to operate right? Right…

But here’s the thing, income does not affect investment (For the introductory level of economics, yes. You will learn how income affects investment next year, for UOL students). So what affects investment DECISIONS then?

It is the real interest rates that determine the decisions made by investors. Real interest: Simple term for now. It’s basically the normal interest rates that banks are offering you for putting in your money their vaults LESS the inflation rate. (The inflation rate is the rate of how much prices rise, it’s a pretty disliked thing….)

So what do interest rates affect investment decisions? Okay, you know that by investing, you expect to get a certain return from it right? You have to! If you don’t, then why did you invest in the first place? So this is what affects investment decisions: REAL INTEREST RATES VERSUS RETURN FROM INVESTMENT.

Here’s the good news: you only have to look at the interest rates. Why? Well look at it this way,

  • If interest rates fell, it would be more attractive putting my money into investments because I might get a higher return
  • If interest rates rose, it would be more attractive to put my money in the bank so that I can earn interest income

See, it’s all about opportunity cost.

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3 Comments

  1. Parag says:

    I guess thr is a small mistake in the mind map regarding the investment function formula. There should be a – instead of +..

  2. Parag says:

    Shouldnt it be i = r + inflation…