Investment (macroeconomics)
Investment, in macroeconomics, means something narrower than the word suggests in daily conversation. One definition puts it plainly: investment "consists of the additions to the nation's capital stock of buildings, equipment, software, and inventories during a year." A second definition calls it investment spending: "spending on productive physical capital such as machinery and construction of buildings, and on changes to inventories." That spending counts as part of total spending on goods and services each year.
Four different kinds of activity get counted under those definitions. A formula ties the total directly to a nation's overall output, and a handful of forces push that total higher or lower each year.
A house keeps delivering shelter to its occupants for years after it is built. That long stretch of service is what defines residential investment.
New machinery or a new factory building falls under non-residential fixed investment instead. Spending on equipment that a plant will use for years fits this category too.
Workforce education is treated the same way, counted as an investment in human capital. Training a workforce, in this framework, builds up a kind of capital just as machinery does.
Goods inventories pile up too, whether a business intends the buildup or not, and that accumulation counts as inventory investment. A warehouse that ends the year holding more stock than it started with has, in this sense, invested.
Fixed investment itself is only ever a flow, spending measured over a stretch of time such as a year. The capital it produces, unlike that flow, is a stock, built up from net additions accumulated to that moment.
Gross investment is one of the pieces that make up a country's total output for the year, alongside consumption, government spending, and net exports. Subtract consumption, government spending, and net exports from total spending, and whatever is left over is investment.
Net exports themselves are simply the gap between what a country exports and what it imports. That gap can run positive or negative depending on which side of the ledger is larger.
Depreciation gets deducted from that gross figure to arrive at net investment instead. Net fixed investment specifically captures how much larger the capital stock has grown, net of depreciation, across a single year.
That net figure moves in either direction each year, shrinking whenever depreciation outpaces new spending on capital.
Interest rates pull in the opposite direction of investment, since a higher rate raises the cost of acquiring the funds needed to buy investment goods. Borrowing to fund new capital gets less attractive every time that rate climbs.
Income pulls investment the opposite way from interest rates. When income rises, it points to a larger market for whatever physical capital can produce, encouraging more spending on it.
Tobin's q offers another lens: it divides what a physical asset would sell for by what it would cost to replace. When that ratio tops one, a firm can buy machinery at one price yet produce output whose market value is larger, a positive economic profit.
A different strand of research ties investment to how far the current capital stock sits from an optimal level. It models investment as an increasing function of that distance. The optimal stock itself is defined as whichever level maximizes profit.
Whenever the current stock falls short of that profit-maximizing optimum, the model predicts investment should rise until the gap disappears.
Common questions
What is investment in macroeconomics?
Investment in macroeconomics is defined as the additions made to a nation's capital stock of buildings, equipment, software, and inventories during a year. It is also described as spending on productive physical capital, such as machinery and construction of buildings, plus changes to inventories, counted as part of total spending on goods and services.
What are the different types of investment in macroeconomics?
Investment in macroeconomics includes residential investment in housing, non-residential fixed investment in things like machinery or factories, human capital investment in workforce education, and inventory investment, the accumulation of goods inventories, whether intentional or unintentional.
What is the difference between gross investment and net investment in macroeconomics?
Gross investment is a component of a country's total output, alongside consumption, government spending, and net exports. Net investment deducts depreciation from that gross figure, and net fixed investment measures the net increase in the capital stock over a year.
How does the interest rate affect investment in macroeconomics?
A higher interest rate negatively affects investment in macroeconomics because it raises the cost of acquiring the funds needed to purchase investment goods. Higher income has the opposite effect, positively affecting investment because it signals greater opportunities to sell what capital can produce.
What is Tobin's q and how does it relate to investment in macroeconomics?
Tobin's q is the ratio between a physical asset's market value and its replacement value, and investment in macroeconomics is modeled as an increasing function of that ratio. When the ratio is greater than one, machinery bought at one price can generate output worth a larger market value, producing positive economic profit.
Is investment a stock or a flow in macroeconomics?
Investment in macroeconomics is a flow, since it is expenditure measured over a period of time such as a year. Capital, by contrast, is a stock, representing accumulated net investment up to a point in time.