Investment - Econlib - 0 views
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nvestment is one of the most important variables in economics.
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By investment, economists mean the production of goods that will be used to produce other goods. This definition differs from the popular usage, wherein decisions to purchase stocks (see stock market) or bonds are thought of as investment.
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Investment is usually the result of forgoing consumption. In a purely agrarian society, early humans had to choose how much grain to eat after the harvest and how much to save for future planting. The latter was Investment.
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In a more modern society, we allocate our productive capacity to producing pure consumer goods such as hamburgers and hot dogs, and investment goods such as semiconductor foundries. If we create one dollar worth of hamburgers today, then our gross national product is higher by one dollar.
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Investment need not always take the form of a privately owned physical product. The most common example of nonphysical Investment is Investment in human capital.
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In an economy that is closed to the outside world, investment can come only from the forgone consumption—the saving—of private individuals, private firms, or government.
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In an open economy, however, investment can surge at the same time that a nation’s saving is low because a country can borrow the resources necessary to invest from neighboring countries.
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That economists have a fairly strong understanding of firms’ investment behavior makes sense. A firm that maximizes its profits must address investment using the framework discussed in this article.
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This method of financing investment has been very important in the United States. The industrial base of the United States in the nineteenth century—railroads, factories, and so on—was built on foreign finance, especially from Britain. More recently, the United States has repeatedly posted significant investment growth and very low savings.
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Investment fluctuates a lot because the fundamentals that drive Investment—output prices, interest rates, and taxes—also fluctuate. But economists do not fully understand fluctuations in Investment. Indeed, the sharp swings in Investment that occur might require an extension to the Jorgenson theory.
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In Jorgenson’s user cost model, firms will purchase a machine if the extra revenue the machine generates is a smidgen more than its cost.
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The general conclusion is that there is a gain to waiting if there is uncertainty and if the installation of the machine entails sunk costs, that is, costs that cannot be recovered once spent.
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Although quantifying this gain exactly is a highly mathematical exercise, the reasoning is straightforward. That would explain why firms typically want to invest only in projects that have a high expected profit.
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The theory of investment dates back to the giants of economics. irving fisher, arthur cecil pigou, and alfred marshall all made contributions; as did john maynard keynes, whose Marshallian user cost theory is a central feature in his General Theory.
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Consumer behavior is harder to study than firms’ behavior. Market forces that drive irrational people out of the marketplace are much weaker than market forces that drive bad companies from the market.
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Because the saving response of consumers must be known if one is to fully understand the impact of any investment policy, and because saving behavior is so poorly understood, much work remains to be done.