Investment and Economic Activity

Read this chapter to examine factors that determine private investment and its link to output within the macroeconomy. Private investment plays an important role in the short run by influencing aggregate demand, and in the long run by influencing the rate of growth of the economy.

14.1 The Role and Nature of Investment

Components of Investment

Additions to the stock of private capital are called Gross Private Domestic Investment (GPDI). GPDI includes four categories of investment:

  1. Nonresidential Structures. This category of investment includes the construction of business structures such as private office buildings, warehouses, factories, private hospitals and universities, and other structures in which the production of goods and services takes place. A structure is counted as GPDI only during the period in which it is built. It may be sold several times after being built, but such sales are not counted as investment. Recall that investment is part of GDP, and GDP is the value of production in any period, not total sales.
  2. Nonresidential Equipment and Software. Producers' equipment includes computers and software, machinery, trucks, cars, and desks, that is, any business equipment that is expected to last more than a year. Equipment and software are counted as investment only in the period in which they are produced.
  3. Residential Investment. This category includes all forms of residential construction, whether apartment houses or single-family homes, as well as residential equipment such as computers and software.
  4. Change in Private Inventories. Private inventories are considered part of the nation's capital stock, because those inventories are used to produce other goods. All private inventories are capital; additions to private inventories are thus investment. When private inventories fall, that is recorded as negative investment.

Figure 14.1 "Components of Gross Private Domestic Investment, 1995–2011" shows the components of gross private domestic investment from 1995 through 2011. We see that producers' equipment and software constitute the largest component of GPDI in the United States. Residential investment was the second largest component of GPDI for most of the period shown but it shrank considerably during the 2007–2009 recession and has yet to recover.

Figure 14.1 Components of Gross Private Domestic Investment, 1995–2011

This chart shows the levels of each of the four components of gross private domestic investment from 1995 through 2011. Nonresidential equipment and software is the largest component of GPDI and has shown the most substantial growth over the period.