Business Courses/Economics 102: MacroeconomicsCourse
- AuthorNicolaas Ackermann
Nicolaas has four years of professional work experience - having worked in hospitality, journalism, and marketing. He has a BA in Communication studies from the North-West University and has completed his TEFL qualification. He also has six years of writing experience complementing his qualified competence.
View bio - InstructorJon Nash
Jon has taught Economics and Finance and has an MBA in Finance
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Learn what investment is in economics. Understand the macroeconomic importance of investment, and review real-life examples of investment in economics.Updated: 11/21/2023
Table of Contents
- What is Investment in Economics?
- Investment and Savings
- Lesson Summary
Frequently Asked Questions
What are the types of investment in economics?
Investments in economics can either be financial or economic. Financial investments pertain to the purchase of financial products like bonds, whereas economic investments relate to buying business capital like new machinery.
Is economic investment good?
Economic investment is definitely a good thing. The main benefit of it is found in how it strengthens the company and its production process.
What is investment in economics?
Investments can either be economic or financial. Economic investments relate to the purchasing of goods and services necessary for production.
What is an example of investment in economics?
Economic investments are acquisitions made by companies to add input to their production. These acquisitions can be new machinery or a bigger factory.
Table of Contents
- What is Investment in Economics?
- Investment and Savings
- Lesson Summary
Investment in macroeconomics refers to gross private domestic investment. This pertains mainly to business spending, as opposed to consumer spending. Economic investments are the investments made by businesses to drive their production. In theory, these investments tend to be solely based on the input side of production. When economists use the word 'investment,' they're not referring to financial investments such as 401-K's and stock or bond purchases. They are referring to business activities within the economy that lead to the production of other goods and services. Investment is the value of all goods and services produced for use in the production of other goods.
Characteristics of economic investment pertain to how they're made when they're made, and scope:
- How: Economic investments are made via the purchase of real assets like labor, land, or production machinery
- When: Most commonly, the biggest portion of economic investment is made during the startup stages of a business when all the needed assets need to be bought
- Scope: The scope of economic investment pertains to the size of the business
As with any investment, economic investments have no guarantees. The purchase of brand-new machinery doesn't fully guarantee increased efficiency as the machine could break down. Similar to the acquisition of new labor - it's never a 100 percent certainty that the newly hired employee will perform at the required level. The only way to ensure the effectiveness of economic investment is through a detailed study of markets, products, and the company's own needs. Economic investments do not have a speculative element to them. They aren't normally made with the notion that the asset in question will be sold off later for a profit.
Investment vs. Economic Investment
There are distinctions between investments (also known as financial investments) and economic investments. These distinctions relate to the assets they invest in, their goals, their range, and the types of companies that make them.
- Assets: Financial investments look at assets such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), and real estate. Economic investments have a narrower scope comprising of investments in machinery, land, and labor
- Goals: The prime goal of financial investments is to generate capital gains. Financial investments are commonly made with the intention of selling the asset again in the future. Economic investments are aimed at enhancing the production process
- Range: Financial investments essentially capture all types of investments. Economic investments are regarded as a category of financial investments. This is due to how assets within the range of economic investments can also be purchased with the objectives of financial investments. For example, a factory machine can be subject to a repurchasing agreement (which is a capital asset)
- Companies: Companies that make financial investments tend to be larger organizations operating on higher levels of an enterprise. Such companies look to secure and build on their position by buying sophisticated assets like bonds and stocks. On the contrary, economic investments are usually made by emerging businesses. These small businesses aim to expand and thus purchase real assets like machinery and other factory equipment. Small businesses don't have the need to purchase financial products like stocks and bonds
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Investment Importance
The value of an investment is its foundational contribution to advancement. Investment indirectly leads to the growth of an economy. When a company makes an investment - for example buying a new production machine - it naturally enhances its production process. This enhanced production process results in more efficiency. Increased efficiency means it can produce more goods of higher quality. This improved output leads to stronger profits (capturing the company's advancement). The combined advancement of companies within an economy is what ultimately drives economic growth. The importance of investment is further found in how imperative it is for companies to constantly grow in the modern age of industry. It is extremely difficult to stay competitive when one's competition is outgrowing you. This principle of importance behind investment enables it to affect virtually every component of an economy. Labor is one of these components in that it can be greatly affected by the investment decisions a company makes. However, labor in itself carries some intrinsic weight because of its importance. A company cannot allocate zero capital towards its employees due to how crucial employees are in the production process.
Investment Examples in Economics
Broad types of economic investment categories are business expenditures, new residential housing, and changes in business inventories. All the things that go into the production process for consumer goods, such as the manufacturing equipment at a product factory, or buildings that house businesses along with the equipment that businesses use to supply goods and services to consumers, are considered investments. The investment would include manufacturing equipment that produces consumer goods. Changes to the inventories of businesses are considered investments in the year in which products are produced. They're only counted as consumption in the year that they are purchased, while an adjustment is also made subtracting them from inventory at the same time. This enables economists to count the production of goods, even though we don't know when they will be sold.
A more simple example of economic investment is a farmer buying a brand-new tractor. The cost will be a drawback for the farmer in the short term. In the long run, however, the new vehicle will first balance expenditures before driving profits. This is of course subject to the tractor's longevity since no investment has a 100 percent guarantee. Its production output is naturally dependent on its functioning. When the tractor breaks the farmer's finances will take a hit and he'll have to look into other investments in order to compensate.
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Saving money and investing money are two distinctly different concepts. The primary differences between the two are defined by the increased safety of saving over investing and the fact that investing provides the possibility of higher returns than saving. However, theory directly connects savings with investments in an economy. This is explained by how money that is accumulated gets loaned out to entrepreneurs who then invest in the economy. Theory suggests that the two concepts are almost interdependent. If no one is saving their money with banks, banks won't have money to lend out to entrepreneurs who invest it. On the other hand, if everyone is just saving and not aiming to invest, there would be no economic growth.
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An investment is defined as the purchase of an asset with the objective of generating appreciation or income. Characteristics of economic investment pertains to how they're made when they're made, and scope. The two types of investments are financial investments and economic investments. The main differences between the two relate to the assets they invest in, their goals, their range, and the types of companies that make them. The importance of economic investment is found in how crucial it is to the ultimate development of any economy. Examples of this type of investment are business expenditures, new residential housing, and changes in business inventories.
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Video Transcript
Investment
All right, we need to spend a little time talking about the word 'investment,' and we need to make a very important distinction. Just imagine this:
One of your neighbors (we'll call him Bob) owns a well-known lawn-cutting business. Bob cuts lawns all day long, especially during the summer months, of course. When he earns income from his business, he takes some of that income and decides to invest some of it into the stock market, buying 500 shares of Felix Homemade Ice Cream Stores. Let's say that this year was extremely profitable for Bob, and he notices that the demand for lawn-cutting services is increasing. Early in the year, he had 50 customers, but suddenly, 25 additional customers have just signed agreements for lawn-cutting services with Bob.
When Bob had 50 lawns, he was able to cut them all by himself using one mower throughout the week and just going from lawn to lawn. However, with 25 new customers and a full schedule of mowing already, that means that Bob's going to have to expand his lawn service in order to increase the supply of lawn cuts so he can meet rising demand. How does Bob expand? By investing into his business, which will end up flowing through the economy. For example, he invests by purchasing another lawn mower and also by hiring a worker.
Time-out. I want you to notice that I used the same word, 'invest,' to describe both of these two events. When Bob saved some of his income and purchased a stock, he called it investing. When he wanted to expand his business, though, he might describe it as 'buying more equipment' or 'expanding,' but economists call that investment. Understanding the difference between these two things is necessary to understand economics.
When we hear the word investment in economics, it refers to gross private domestic investment, and it's not referring to investments that most of us are familiar with, such as our 401-Ks or mutual funds. Investment is the value of all goods produced during a period for use in the production of other goods and services. So, all the things that go into the production process for consumer goods, such as the manufacturing equipment at a product factory, or buildings that house businesses along with the equipment that businesses use to supply goods and services to consumers. In the case of a service business, like Bob's lawn service, the purchase of additional mowers, as well as hiring a worker, were purchases that were made in order to provide the service of lawn mowing. These are considered investment.
We often hear and use the word investment in society, but most people are not referring to gross domestic private investment. When we say we purchased an investment in a large company stock, we're talking about a financial investment of money that either earns interest or has the potential to increase in value. Economists, on the other hand, use the term 'investment' to describe all the activities that lead to capital investments within an economy. They call the financial investments 'savings.'
Ingredients of Investment
Let's talk about the three main ingredients inside the investment component of our GDP:
- Business expenditures
- New residential homes constructed
- Changes in business inventories
The first category is business expenditures. When Bob's low-rider mowing service buys a new lawn mower today, this is considered an investment and is counted in our GDP for this year.
The second category is new residential housing. When Bob's business takes off, he decides to use some of his profit to build a new house. Once his house is constructed, this is now included in the investment component of our GDP.
Finally, changes to the inventories of businesses across the country are considered investment in the year in which products are produced. For example, let's say that, in addition to lawn cutting, Bob happens to also sell fertilizer bags to consumers who are interested. Bob keeps an inventory of fertilizer bags in a small warehouse, and from time to time, he buys more bags to make sure he has enough to offer for sale to his customers. Whenever Bob orders new bags to place in his inventory, the new bags are counted as investment, which gets counted in the GDP for the current year. However, when the bags are sold to customers, they are counted as consumption in the year they are purchased, while an adjustment is also made subtracting them from inventory at the same time. This enables economists to count the production of goods, even though we don't know when they will be sold.
Savings and Investment
Let's talk about the direct connection between savings and investment because this is very important; it makes the economy grow over the long term. In order to invest in the economy, money must be saved. Therefore, there is a direct connection between the amount of savings and the amount of investment in a nation.
For example, when Bob saves some of his income from mowing lawns, he deposits it into a savings account at his local bank. The bank then takes his savings and loans out most of it to an entrepreneur, Mandy, who needs to expand her canned soup business. Bob's savings created the opportunity for Mandy to borrow money and make an investment, which is also an investment into our economy. Savings is directly connected to investment. That's why economists are concerned with the savings rate of a nation.
In addition, for Bob to save some of his income, he had to choose not to spend some of this income. Savings reduces consumption today but leads to investment and, therefore, future growth in the economy.
Lesson Summary
Let's summarize what we've talked about in this lesson. Investment, otherwise known as Gross Domestic Private Investment, is the value of all goods produced during a period for use in the production of other goods and services. When economists use the word 'investment,' they're not referring to financial investments such as 401-K's and stock or bonds purchases. They are referring to business activities within the economy that lead to the production of other goods and services.
The three main ingredients in investment of our GDP include:
- Business expenditures
- New residential homes constructed
- Changes in business inventories
Savings is directly connected to investment in an economy. Investment today requires savings today, but investment produces economic growth that leads to future consumption.
Lesson Objectives
Once you finish this lesson you'll understand the components that make up investment in Gross Domestic Product calculation and its differences with financial investments.
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