Macroeconomics: Consumption, Investment, and Economic Growth
Overall Functioning of the Economy
The macroeconomic objectives are to achieve economic growth, ensure full employment, and maintain price stability. GDP growth leads to improved living standards. However, during crises, companies face challenges selling goods and services, leading to reduced production and hiring. This, in turn, increases unemployment and decreases citizen income.
Influential Factors
Several factors influence a country’s economic progress:
- Internal Market Forces: Changes in population, consumption and investment behavior, innovation, and technology.
- External Shocks: Political and military conflicts, natural disasters, and droughts.
- Government Performance: Fiscal and monetary policies used to direct and control the economy.
Internal Market Forces
Internal forces operate within the supply and demand market. A country’s production level depends on the amounts companies are willing to sell and consumers are willing to buy.
Aggregate Demand and GDP
Aggregate demand represents the total expected expenditure of an economy. It comprises consumer spending, private investment, government spending, and net exports (exports minus imports). Excluding foreign trade, we get domestic demand.
Consumption and Saving
Consumption refers to total household expenditure on goods and services within a given period.
Factors Influencing Consumption
- Disposable Income: Consumption increases with rising income. Permanent income is the average income over a lifetime.
- Interest Rates and Credit Facilities: Lower interest rates make borrowing cheaper, encouraging consumption.
- Lifespan: Younger and older individuals tend to spend more of their income than those of intermediate ages.
Savings
Savings are the portion of income remaining after consumer spending. People save for various reasons:
- Protection against unforeseen circumstances (illness, unemployment).
- Funding significant expenditures.
- Generating supplemental income through investments.
Indicators of Consumption Trends
- Household Budget Surveys: Capture expected family spending.
- Car Registrations: Reflect consumer spending on automobiles.
- Large Store Sales: Indicate sales trends in supermarkets and large retailers.
- Other Indicators: Such as gasoline consumption.
Consumer Confidence
The consumer confidence index is a key indicator of future consumption. Changes in consumer confidence often precede similar economic shifts.
Investment
Economic investment involves acquiring capital goods to produce other goods. In national accounts, investment includes:
- Investment in plant and equipment.
- Construction of residential housing.
These components form gross fixed capital formation (GFCF), representing 20% of GDP.
Types of Financial Investments
- Replacement Investment: Replacing worn-out machinery and equipment.
- Renewal Investment: Replacing outdated but functional equipment.
- Expansion Investment: Acquiring new equipment to increase production.
Determinants of Investment Demand
- Interest Rates: Borrowing costs influence investment decisions.
- Capacity Utilization: Companies are less likely to invest if they are not operating at full capacity.
- Future Confidence: Investment decisions have long-term implications for companies.
The Investment Multiplier Effect
Investment decisions have a ripple effect, generating positive impacts that multiply throughout the economy.
Investment Multiplier Formula
Increased Spending = Initial Investment * 1 / (1 – MPC)
Profitability Formula
Profitability = (Profit Earned / Capital Invested) * 100