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Investment Demand Schedule Diagram


Investment refers to expenditures on inventories and capital goods such as plant and equipment, and residential housing.  One important variable would influence investment is interest rate in real term, which is the nominal rate less the rate of inflation.  It is because interest is a key cost (either ”„cost of borrowing”¦ or ”„opportunity cost”¦) of investment that affect expected rate of net profit.  Therefore, higher interest rates de-motivate investment, and conversely, ceteris paribus.  This change is reflected in movements along investment-demand curve (ID curve) as shown in Figure 1.

As investment is profit motive, direct costs are hence sensitive.  Investment may involve land, capital and labor incurring acquisition, operating and maintenance costs.  So rise of these costs decrease expected rate of net profit and investment falls, shifting ID curve to the left, and conversely, ceteris paribus

Business taxes affect the profitability of investment.  An increase in business tax means decreasing expected rate of net profit and discourage investment, shifting ID curve to the left, and conversely, ceteris paribus.

The pace of technological change also affects investment decisions.  Fast technological change helps to improve efficiency and effectiveness to gain competitive advantage.  It increases expected rate of net profit and stimulates investments, shifting ID curve to the right, and conversely, ceteris paribus

The level of stock of capital goods like productive facilities, production capacity and inventories reveals the demand in finished goods.  High level of capital goods means low demand in finished goods, expected rate of net profit for future is low.  So investment decreases, shifting ID curve to the left, and conversely, ceteris paribus

Expectation in business environment is an important determinant for investment.  Optimistic expectation about future business conditions increases expected profitability and investment, shifting ID curve to the right, and conversely, ceteris paribus.

The ID schedule diagram (Figure 3) demonstrates how investment still rises even though interest rates increase.  The future expectation of Hong Kong before Asian economic crisis was optimistic.  Technology change was under a fast pace like Internet improving information flow.  Household consumption was high causing fast flow of capital goods.  Assume acquisition, operating and maintenance costs were low, plus a rather low business tax.  All these determinants increased investment desire (shifting ID Curve-0 to ID Curve-1 and increased investment from ID1 to ID2) even with an increase in interest rates (IR0-IR1).

GDP is a basic measure of national economic performance.  Investment is more instability than the other components of GDP as investment is variable and volatile.  Many factors would affect the desire or level of investment such as: (1) the durability of capital goods, (2) irregularity of innovation, (3) variability of profits, and (4) variability of expectations, etc.  Hence investment is considered as an important component of GDP because it can have economic (national wealth) and social (like technological improvement) benefits through creation of economic multipliers and business opportunities.


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