When using the term investment it refers directly to the acquisition of new capital such as buildings, machines or offices. Firms will usually make the decision to invest on the expectation to make a gain. Investments made by businesses or firms usually involve millions of dollars, making investment a very big important decision with many different factors to take into account. There are four main factors, which would most likely influence a decision regarding investment, they include the current rate of interest, future expectations, the level of income, the government and the accelerator theory.
Interest Rates
Interest rates are a variable rate which are manipulated through government policies whenever the economy is not stable. Interest rates have an influence on investment as you can see from the two following figures. Most decisions to invest involve borrowing money, so we can assume that there is an association between the cost of borrowing and the level of investment.
Investments usually involve large sums of money. In order to acquire this money firms must take out loans. Interest rates can be defined as the cost of borrowing or the reward for saving. If interest rates are high this will make borrowing more expensive making saving more encouraging. In contrast if interest rates are low this makes borrowing a more attractive offer. Firms are more likely to consider an investment at a low rate of interest. This shows us what kind of impact interest rates has on investment.
The Research paper on Effect of Interest Rate on Investment Determination in Nigria
... investment function, the quantity of investment depends on the real interest rate because the interest rate is the cost of borrowing. The investment function slopes downward when the interest rate ... relationship between investment and interest rate in Nigeria. (b) To empirically investigate the effect of interest rate on investment determination in Nigeria. (c) To make recommendations based ...
Future Expectations
Another factor that has a significant effect on investment, are a firms future expectations. If investment yielded an 11% increase and the current rate of interest was 10% investment would take place. However the future is unpredictable, because investment decisions take time to accomplish, there is usually a great deal of uncertainty. What businesses expect to happen in the future is very important. If a business’ management is feeling pessimistic about the future, low interest rates will not encourage investment. On the other hand high interest rates will not deter them from making an investment if they are feeling confident and optimistic about the future. This idea in a way contradicts our previous idea; this shows us that there are possibly a lot more than four or five factors that influence investment.
Income
A high level of income is another factor which stimulates investment; high levels of income tend to make businesses feel more optimistic about the future. Furthermore high levels of income could mean high profits. Therefor businesses have more funds with which to invest. Many economists believe that high levels of income occur as a result of high levels of investment. This follows a circular flow pattern. Whichever way you see it income has a clear association with investment
The Accelerator Theory
The accelerator principle states that a change in the rate of income or output will vary the level of investment. This is similar to the idea; changes in consumption relate to the level of investment. If the demand for a product is increasing in order for firms to be able to meet the demand increased investment is necessary. The table below gives an example supporting this theory.
The Essay on Lowering Government Taxes Lower Income
Difficult Decisions Dear President Bush and Congress: I have written you to discuss our national budget and the inherent problems in our fiscal policy. Although I am not the best informed on this subject I think my opinions and ideas are relevant. I have several ideas for both raising more capital and lowering government expenditure. I believe action must be taken on both fronts to curb our ...
Firms however must need to ask themselves if the increased demand will last or will it be short lived. Firms who feel that the increased demand will be short lived then they would choose to not invest.
Government
The government has a big effect on investment in two different ways. Indirectly through government policies and directly by being the largest investor in the economy. Investment decisions made by firms are influenced by government taxation, which may give either positive or negative incentives (usually negative in order to reduce externalities).
Fiscal and monetary policies are the government’s tools that deal with tax and interest rates, they both have a significant effect in determining investment.
The government and public corporations hold over 14% of all fixed capital in the country. The governments investments are not always profit orientated, they may be guided by other motives (benefiting society), including the construction of schools, hospitals, roads and old people’s homes. Many economists believe that the government aims to stabilise the levels of total investment within the economy. When private investment is low government or public investment will be high and vice versa. Many argue that from time to time they crowd out private investment, which lowers the overall level of private investment.
Conclusion
As we can see from all the examples given, there is clear evidence that many different aspects will influence the decision to invest. Different economists would disagree with each other on what determines investment. The only idea where there is no disagreement between economists is the future expectations of firms and businesses. I believe that all of the factors mentioned in this paper would have some sort of effect on investment, some more than others would.
