Investment

Gross and net investment

Gross investment is total spending on new capital goods. Some of it simply replaces capital that has worn out (depreciation, or capital consumption).

Net investment = gross investment - depreciation. Only net investment adds to the capital stock; if it is negative, the capital stock is shrinking.

Influences on investment

• Rate of economic growth: faster growth of demand means firms need more capacity (the accelerator: investment depends on the rate of change of output).
• Interest rates: higher rates raise the cost of borrowing and the opportunity cost of using retained profits, so fewer projects are profitable.
• Business confidence and expectations ('animal spirits'): optimism raises investment; uncertainty delays it.
• Availability of credit: banks' willingness to lend.
• Tax on company profits: lower corporation tax leaves more retained profit and raises the post-tax return on projects.

Government policies to promote investment

• Tax relief, such as investment allowances that let firms deduct capital spending from taxable profit.
• Subsidies and grants for investment, for example in green technology or deprived regions.
• Reductions in corporation tax.

Investment matters twice: it raises AD now and shifts LRAS right later by increasing productive capacity.

Worked example

Gross investment is $240 bn and depreciation is $190 bn. Find net investment and explain what happens to the capital stock.

1. Net investment = 240 - 190 = 50
2. Net investment is positive, so the capital stock grows.

Answer: $50 bn; the capital stock increases by $50 bn

Check yourself

1. Gross investment is $85 bn and depreciation is $97 bn. Find net investment in $ bn.
   Show answer

   -12 bn. 85 - 97 = -$12 bn: the capital stock is shrinking.

2. Net investment is $30 bn and depreciation $110 bn. Find gross investment in $ bn.
   Show answer

   $140 bn. Gross = net + depreciation = 30 + 110 = $140 bn.

3. Investment falls from $250 bn to $215 bn. Find the percentage change.
   Show answer

   -14 %. (215 - 250) / 250 x 100 = -14%.

4. A rise in interest rates reduces investment mainly because
   • fewer projects earn a return greater than the cost of borrowing
   • it raises consumer confidence
   • it lowers the cost of capital goods
   • it increases retained profits
   Show answer

   fewer projects earn a return greater than the cost of borrowing. Higher borrowing costs and opportunity cost mean fewer projects are worthwhile.

5. The accelerator theory states that investment depends on
   • the level of interest rates only
   • the level of savings
   • the rate of change of national output
   • the size of the budget deficit
   Show answer

   the rate of change of national output. Firms invest when demand is growing and they need more capacity.

6. Which government policy is most directly aimed at increasing private investment?
   • Allowing firms to deduct capital spending from taxable profits
   • Raising income tax
   • Increasing unemployment benefits
   • Raising interest rates
   Show answer

   Allowing firms to deduct capital spending from taxable profits. Investment allowances (tax relief) raise the post-tax return on capital projects.

7. Why is investment usually the most volatile component of AD?
   • It is set by the government each year
   • Households decide it
   • It depends heavily on uncertain expectations about future demand
   • It is always financed by saving
   Show answer

   It depends heavily on uncertain expectations about future demand. Confidence and expected growth can swing sharply.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2 (June 2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.