hi everybody let's continue by looking at the determinants of investment investment is a key part of the aggregate demand equation and if investment increases or decreases aggregate demand will shift either right or left investment can mean many different things so in economics by default we say that investment is when firms spend money on capital goods to increase their productive capacity so always go there by default when firms spend money on capital goods that's what we mean by investment in economics so what factors can influence the level of investment well interest rates can firms will finance
investment in two main ways either by borrowing money or by investing I've retained profits that they have so interest rates are crucial therefore when it comes to borrowing money isn't it so if interest rates are low in the economy means that the cost of borrowing is low it means that firms have got a greater incentive to borrow money and then to invest the marginal propensity to invest with increase of interest rates are lower what you can also bring in with interest rates is the notion of the hurdle the hurdle is the required rate of return
that firms need for investment projects to go ahead so if interest rates are lower it means reaching that hurdle that required rate of return becomes a bit easier therefore again increasing the marginal propensity to invest increasing borrowing for investment however if interest rates are high the opposite will happen investment will be lower and aggregate demand will shift left the level of business confidence is very important as well in determining investment don't be that student that says oh business confidence is determined by the state of the economy or the expected state of the economy in the
future that is true but it's a bit vague be more specific as to what determines business confidence business confidence is determined by two key Expectations by firms the expectation of future profit and the expert the expectation of future demand in the economy if the expectation of profit and demand in the economy is high going forward then businesses are more likely to invest their marginal propensity to invest is going to be higher to meet the level of demand in the future to make sure that investment takes place whereby they can supply the demand in the future
that they're expecting so high business confidence is likely to incentivize investment whereas the business confidence is low and businesses expect profit to be low in the future they expect demand to be low in the future there is no need to invest to increase capacity is there so low business confidence implies less investment and therefore lower aggregate demand in the economy the level of cooperation tax of course is going to affect investment use the phrase retained profit here retained profit is the profit left after corporation tax has been paid where corporation tax is attacked on business
profits the lower the corporation tax the higher the level of retained property is going to be the greater potential the business has to invest therefore remember what I just said that there are two main ways of financing investment borrowing money or by using retained profits so if corporation tax is low retained profits going to be higher businesses can therefore use social retained profits to invest whereas if Corporation taxes are high retained profits are going to be lower investment is going to be lower spare capacity businesses have got lots of spare capacity there is no need
to invest to buy more Capital Machinery to build a new Factory let's say there is no need to do that because there is so much spare capacity that could be used up instead to increase Supply to increase production so the greater the level of spare capacity the less the marginal propensity to invest the less investment whereas if businesses are operating very close to full capacity then there is a very good incentive to invest to increase capacity the level of competition is massive and the level of technology that there is in the economy if competition is
strong and lots of competitors are improving their technology or spending more on Capital Machinery or innovating or spending more on R D likelihood is that businesses will react to that and also spend money on investment and at least get to a level of technology that is equal to their Rivals if not better than the technology or their Rivals so if competition is high you can expect a huge amount of investment to take place for businesses to get ahead of their competition by bringing in brand new capital more efficient capital or new technology or looking to
increase the size of their factories to produce more to get ahead of their competitors and of course the price of capital Machinery if the price of capital is low then investment is less costly the marginal propensity to invest is higher and investment is likely to increase of course it is don't forget the accelerator effect this is very much linked to investment as well of course it is the accelerator effect is when there is an increasing rate of real GDP in the economy which then encourages further investment a bit like what we've said with respect to
business confidence if the expected level of demand in the economy is going to be high that encourages more investment the accelerator idea is pretty much linked to that and it states that at the rate of real GDP in the economy is increasing that is going to encourage more investment which will increase the rate of real GDP which encourages more investment etc etc so the accelerator ID can also bring in to the whole topic area of investment that covers the determinants of investment thank you so much for watching guys stay tuned for the next video where
we look at government spending I'll see you then
