Components of Investment Function
Components of Investment FunctionSome key elements determine the level of investment in an economy. Here is in-depth explanations of the main components of the investment function:
Interest Rates
Interest rates are simply the cost of taking a loan and, equally, the return on savings.
Impact of Interest Rates
There is definitely an impact of interest rates on the investment function. The lower rates and higher rates have been stated below.
- Lower Interest Rates: Encourage borrowing and investment, as financial costs are reduced, so capital expenditures by business entities will increase.
- Higher Interest Rates: Deter investment as borrowing becomes more expensive, so firms will postpone or reduce investment projects.
Example: A company contemplating investment in expansion will be more likely to invest if the interest rate on loans is low, so that the monthly payment will be low.
National Income
Aggregate amount earned by the factors of production in an economy, hence indicating the general level of activity within that economy.
Impact of National Income
National income has an impact on the investment function. The lower rates and higher rates have been stated below.
- Higher National Income: Higher national income implies stronger economic performance, and businesses invest more to meet the rising consumer demand and capacity extension.
- Lower National Income: The firms will be conservative in terms of investment as they can perceive reduced demand for goods and services produced by them.
Example: firms invest in setting up new facilities and purchasing new equipment during economic expansions to capitalize on the benefit of increased consumer spending.
Business Expectations
Business expectation refers to the perception of firms about future economic conditions and profitability.
Impact of Business Expectations
Business expectation has an impact on the investment function. The lower rates and higher rates have been stated below.
- Positive Expectations: If firms expect growth in the economy, then they will undertake investments in new projects and expansion in existing lines of business.
- Negative Expectations: If firms face expectations of an economic downturn or uncertainty, there has to be a postponed investment or a reduction in the same.
Example: The company can expect a boom in consumer demand and invest in new technology to enhance production capacity.
Government Policies
Through its actions on fiscal policies and regulatory policies, the government has a large impact on investment decisions.
Impact of Government Policies
Government policies have an impact on the investment function. The lower rates and higher rates have been stated below.
- Tax Incentives: Tax breaks or credits increase the attractiveness to invest, raising capital spending.
- Regulatory Environment: A stable and conducive regulatory framework stimulates investment, against a plethora of regulation that deters it.
Example: A government giving tax credits to businesses investing in renewable energy can drive growth in that sector by providing a motive to invest.
Technological Changes
Innovations and technological advancements may influence investment decisions.
Impact of Technological Changes
Technological changes have an impact on the investment function. The lower rates and higher rates have been stated below.
- Technological Improvements: New technologies open possibilities for improving efficiency and productivity and may, therefore, result in increased investment in new systems and equipment.
- Obsolescence: Firms can invest to replace obsolete technology to remain competitive in the marketplace.
Example: The development of automation technology takes manufacturers to invest in advanced machinery to increase productivity.
Capacity Utilization
This describes the extent to which a business is achieving full productive potential.
Impact of Capacity Utilization
Technological changes have an impact on the investment function. The lower rates and higher rates have been stated below.
- High capacity: High capacity use is usually indicative of high demand and typically leads to increased investments in augmenting production capacity.
- Low capacity: Low capacity utilization is an indicator of inadequate demand, and firms become extremely cautious about undertaking fresh investments.
Example: A factory running at full capacity may invest in additional lines of production.
