What is Investment Expenditure?

We call spending on new capital goods investment expenditure. Investment falls into four categories: producer’s durable equipment and software, nonresidential structures (such as factories, offices, and retail locations), changes in inventories, and residential structures (such as single-family homes, townhouses, and apartment buildings). Businesses conduct the first three types of investment, while households conduct the last.

Keynes’s treatment of investment focuses on the key role of expectations about the future in influencing business decisions. When a business decides to make an investment in physical assets, like plants or equipment, or in intangible assets, like skills or a research and development project, that firm considers both the expected investment benefits (future profit expectations) and the investment costs (interest rates).

• •    Expectations of future profits: The clearest driver of investment benefits is expectations for future profits. When we expect an economy to grow, businesses perceive a growing market for their products. Their higher degree of business confidence will encourage new investment. For example, in the second half of the 1990s,

U.S. investment levels surged from 18% of GDP in 1994 to 21% in 2000. However, when a recession started in 2001, U.S. investment levels quickly sank back to 18% of GDP by 2002.

• •    Interest rates also play a significant role in determining how much investment a firm will make. Just as individuals need to borrow money to purchase homes, so businesses need financing when they purchase big ticket items. The cost of investment thus includes the interest rate. Even if the firm has the funds, the interest rate measures the opportunity cost of purchasing business capital. Lower interest rates stimulate investment spending and higher interest rates reduce it.

Many factors can affect the expected profitability on investment. For example, if the energy prices decline, then investments that use energy as an input will yield higher profits. If government offers special incentives for investment (for example, through the tax code), then investment will look more attractive; conversely, if government removes special investment incentives from the tax code, or increases other business taxes, then investment will look less attractive. As Keynes noted, business investment is the most variable of all the components of aggregate demand.

Related Topics

• Keynesian Perspective of Aggregate Demand
• Recessionary and Inflationary Gap
• Consumption Expenditure
• Investment Expenditure
• Government Spending in Aggregate Demand
• Net Exports in Aggregate Demand
• Keynesian Economic Analysis
• Wage and Price Stickiness 
• Coordination Argument of Wage Stickiness
• What are Menu Costs
• Keynesian Assumptions in the Aggregate Demand and Aggregate Supply Model
• Macroeconomic Externality
• Expenditure Multiplier
• The Phillips Curve
• Keynesian Approach to Unemployment and Inflation
• Keynesian Perspective on Market Forces
• NeoClassical Economics
• Long Run Potential GDP
• Physical Capital Affects Productivity
• Potential GDP in the Aggregate Demand Aggregate Supply Model
• Prices are Flexible in the Long Run
• Keynesian and NeoClassical View of Long-Run Aggregate Supply and Demand
• Speed of Macroeconomic Adjustment of Wages and Prices
• Paradox of Rationality
• Rational Expectations Theory
• Shapley Value
• Mechanism Design Theory
• What is the Adaptive Expectations Theory
• Measure Inflation Expectations
• Neoclassical Phillips Curve Tradeoff
• Neoclassical View of Unemployment
• Neoclassical View of Recessions
• Keynesian vs Neoclassical Macroeconomic Policy Recommendations