Download Capital Investment - Oldfield Economics

Capital Investment
Capital investment spending has an important
effect on both the demand and supply side of
the economy. This presentation considers the
basic theories of investment, its impact on AD
and AS.
Capital Investment
Department of Economics
and BusinessBIS Phuket
What is Investment?
Capital Investment
 Is spending on capital goods that will allow increased output of
goods and services in the future
 Investment is not saving in financial assets such as shares and
bonds
• Fixed Capital: plant and machinery, buildings, new
technology
• Working Capital: spending on stocks of finished goods and raw
materials / components
• Human Capital (not included in the investment data) –
building up the stock of human (labour) qualities and skills
Capital Investment
Why Invest?




More Demand
Improve efficiency through better technology
Exploit economies of scale (lower LRAC)
Investing in new technology to remain competitive against other
producers
Capital Investment
Factors affecting Investment
• The rate of interest- higher interest rates increases the cost
of borrowing by firms and may make some investments
unprofitable. It may also affect….
• Consumer demand- higher demand requires higher output,
and therefore increased productive output. This may itself be
affected by
• Spare capacity. If demand is increasing, but firms have spare
capacity then they may not need to invest in additional
machines etc
• Firms’ Profitability. If profits are high then they can afford
to invest. It also has an impact on….
• Business confidence. If this is high then businesses may
invest more
• Government Policies- such as subsidies and incentives to
invest
• Banking and Financial institutions support to businesses.
Capital Investment
The Importance of Spare Capacity
SPARE CAPACITY IN MANUFACTURING INDUSTRY
% of manufacturing firms operating with spare capacity
Low levels of capacity utilisation
act as a constraint on investment
80
70
60
50
40
30
20
88
89
90
91
92
93
94
95
96
97
98
99
00
01
When demand is high and many businesses are operating close to full capacity, then planned
capital spending may rise – businesses are looking to expand their production potential by
adding to their existing capital stock
Capital Investment
Importance of Business Confidence
Investment projects inevitably involve a degree of risk
 Revenue streams are uncertain (particularly in industries and
markets that are sensitive to cyclical and exchange rate
fluctuations)
 Costs are subject to change over time
 There is no guarantee that a project will yield the expected (or
required) rate of return
Changes in business confidence can have a huge impact on
planned capital spending projects
Confidence is affected by many factors – but is driven mainly by
expectations (e.g. of future demand, costs, taxation etc)
A drop in business optimism can lead to delays in capital
projects being given the go ahead or cancellations of entire
projects
Capital Investment
Business Confidence Trends
BUSINESS OPTIMISM AND PLANNED INVESTMENT
net balance of respondents
40
20
0
-20
-40
Business Optimism
Planned Investment
-60
-80
88
89
90
91
92
93
94
95
96
97
98
99
00
01
CBI Industrial Trends Survey (Quarterly)
Business confidence is inherently volatile and unpredictable. Committing a business to
expensive projects requires a cold and calculated assessment of the potential costs and returns
Capital Investment
What Constrains Investment Spending?
Constraints on Capital Investment (CBI Survey Evidence)
Percentage of respondents citing as a factor
Oct 2000
Jan 2001
April 2001
July 2001
Inadequate expected net rate of
profit
51
51
45
40
Shortage of internal finance i.e. from
retained profits
20
18
21
21
Problems in raising external finance
6
3
5
7
The cost of finance (i.e. interest
rates on loan finance)
3
5
3
2
Uncertainty about future demand in
their industry
44
48
56
51
Capital Investment
The Importance of Capital Investment to the
Economy
The Government's central objective is to achieve high and stable
levels of growth and employment. And, to achieve this requires a
sustained expansion of our productive potential.
An increase in the share of national income given to capital
investment is seen as a key source of long-term economic
growth, for new investment can embody technological progress
and act as a stimulant to improvements in labour productivity
Capital Investment
Investment and Aggregate Demand
Investment is an important component of aggregate demand
 A change in investment can have a multiplier effect on the
overall level of national income
 E.g. a £100 million capital project should lead to a much larger
final increase in equilibrium GDP
Initial boost to aggregate demand and output
Employment creation effects
Output generates further incomes and spending through the
circular flow
If extra investment improves the international competitiveness
of Thai businesses in domestic and international markets –
this injects extra demand into the economy through higher
exports
Capital Investment
Investment Adds to Aggregate Demand
LAS
Price level
LRAS
SAS0
Higher capital spending boosts
aggregate demand
Some capital spending leaks
from the circular flow through
imports
105
100
AD0
0
6.0
Capital Investment
Y1
Y2
GDP
AD1
Investment and Aggregate Supply
Capital spending can boost the supply-side of the economy
 We can produce more
 New capital means better technology – improving efficiency
 Often a time lag between new capital investment being used
and efficiency improving
Training required
Investment requires sufficiently high level of demand for it to
be fully utilised/used
Higher levels of investment increase the scope for noninflationary economic growth over time
Capital Investment
Improvements in Long Run Aggregate Supply
Higher rates of capital investment
boost the productive capacity of
the economy – a source of longterm economic growth
LRAS2
Price level
LRAS
If there is a rise in long run
aggregate supply the economy can
now sustain a higher level of
demand
AD2
AD1
0
6.0
Capital Investment
Y3
Y4
Real GDP
Real GDP
If aggregate demand shifts out, the
economy can meet the extra
demand because of the outward
shift in LRAS