Question

How does investment as defined by economists differ from investment as defined by the general public? What would happen to the amount of economic investment made today if firms expected the future returns to such investment to be very low? What if firms expected future returns to be very high?

Short answer

Economic investment focuses on capital goods, while general public invests in financial assets. Low expected returns reduce investment; high returns increase it.

Step-by-step solution

Define Economic Investment

Economic investment refers to the spending on capital goods like machinery, buildings, and technology that will be used to produce goods and services in the future. It is focused on increasing productive capacity and future output.

Define Investment by the General Public

In contrast, the general public often refers to investment as the purchase of financial assets like stocks, bonds, or real estate in hopes of earning a financial return.

Analyze Low Expected Future Returns

If firms expect future returns on investment to be very low, they are likely to reduce their economic investment. This is because the potential profits do not justify the risks and costs of investing in new or expanded capital goods.

Analyze High Expected Future Returns

Conversely, if firms expect future returns to be high, they will likely increase their economic investment. The anticipated profits provide a strong incentive to invest more in capital goods to capitalize on favorable market conditions.

Key concepts

Capital Goods

Capital goods are the backbone of economic investment. They include physical assets like machinery, buildings, and technology that are used in the production of other goods and services. These are not the products that are consumed directly by customers; instead, they are the tools and infrastructure that businesses use to produce final products. For example, a delivery van for a courier company is considered a capital good because it is used to deliver packages, thereby facilitating service delivery.
Investing in capital goods is crucial for businesses looking to expand their operations or improve efficiency. Without such investments, it would be challenging to increase output or maintain competitive in the market. These investments typically require a significant amount of capital upfront, but the long-term benefits include increased productivity and expanded production capacity.

Future Returns

Future returns refer to the potential profits or benefits that businesses expect to gain from their investments in capital goods. The decision to invest in new technology or expand current operations is significantly influenced by the anticipated future returns. If a company believes that investing in new machinery today will result in higher profits tomorrow, it is more likely to make that investment.

• High future returns incentivize firms to invest more, as they expect these investments to yield substantial profits.
• Conversely, if expected future returns are low, firms may decide to hold back from making new investments due to the uncertainty of sufficient rewards.

Thus, the expectation of future returns directly impacts economic investment decisions, guiding firms on whether to allocate their resources towards growing their production capabilities.

Productive Capacity

Productive capacity is the maximum potential output that a company or economy can produce when it utilizes all of its resources efficiently. Economic investments in capital goods directly enhance a firm's productive capacity. By upgrading machinery, building more factories, or adopting advanced technologies, firms can increase the amount of goods or services they can produce.
This concept is fundamental for growth, as a higher productive capacity means a business can meet greater demand without proportionally increasing production costs. Strategic investments allow companies to scale efficiently, adapt to market changes, and gain a competitive edge.
It's essential for firms to periodically assess their productive capacity, as this evaluation guides them in identifying areas where investments are needed. Continuous improvement in productive capacity is vital for sustaining long-term growth and profitability.