In terms of the whole economy, the amount of business profits is a good indication of the potential reward for investment. This means that businesses, entrepreneurs, and capital owners will require a return on their investment in order to cover this risk, and earn a reward.
Investment is a sacrifice, which involves taking risks. The main determinants of investment are: The expected return on the investment This is because the underlying determinants also have a tendency to change. The level of investment in an economy tends to vary by a greater extent than other components of aggregate demand.
In economic theory, net investment carries more significance, as it provides the basis for economic growth. This relationship is expressed in the following equation: Net investment = gross investment – depreciationįor example, if an airline replaces five worn out aircraft with identical new aircraft, and purchases two more aircraft in order to be able to fly to more destinations, then gross investment is seven, replacement investment is five, and net investment is two. Gross investment includes both types of investment spending, but net investment only measures new assets rather than the replacement of assets. This will reduce long-term costs, increase competitiveness, and raise profits.