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.

14.4 Review


Investment is an addition to the capital stock. Investment may occur as a net addition to capital or as a replacement of depreciated capital. The bulk of investment spending in the United States falls into the latter category. Investment is a highly volatile component of GDP.

The decision to save is linked directly to the decision to invest. If a nation is to devote a larger share of its production to investment, then it must devote a smaller share to consumption, all other things unchanged. And that requires people to save more.

Investment is affected by the interest rate; the negative relationship between investment and the interest rate is illustrated by the investment demand curve. The position of this curve is affected by expectations, the level of economic activity, the stock of capital, the price of capital, the prices of other factors, technology, and public policy.

Because investment is a component of aggregate demand, a change in investment shifts the aggregate demand curve to the right or left. The amount of the shift will equal the initial change in investment times the multiplier.

In addition to its impact on aggregate demand, investment can also affect economic growth. Investment shifts the production possibilities curve outward, shifts the economy's aggregate production function upward, and shifts the long-run aggregate supply curve to the right.