May 23, 2024 

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RELATIVE POVERTY LEVEL: The amount of income a person or family needs to purchase a relative amount of basic necessities of life. These basic necessities are identified relative to the current structure of society and the economy. For example, while a refrigerator would be a basic necessity for someone living in the our modern U.S. economy, it probably would not be consider a necessity for nomads of sub-Saharan Africa or aborigines of Australia.

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The sacrifice of current benefits or rewards to pursue an activity with expectations of greater future benefits or rewards. Investment is the mechanism used to increase the economy's production capabilities and generate economic growth. Investment is typically used to mean the purchase of capital by business in anticipation of profit, which is termed investment expenditures.
Investment is the process of foregoing current satisfaction achieved with the consumption of goods and services to pursue activities that are expected to generate greater satisfaction in the future. The most noted activity pursued with investment is the production of capital goods. Other investment activities, such as education, scientific research, and the exploration for natural resources, are also important. Investment, especially that involving capital production, is often financed by selling legal claims through financial markets. This is the primary reason that many people commonly associate the term investment with the purchase of financial assets.

Sacrificing Today

Investment entails sacrifice. Resources used to pursue investment activities cannot be used to generate current consumption. The general nature of this process can be illustrated using the production possibilities curve to the right.

This production possibilities curve illustrates alternative combinations of two goods--crab puffs (a consumption good) and storage sheds (a capital good)--that can be produced by society with existing resources and technology. As a capital good, storage sheds add to the quantity of available resources, which expands the economy's production capabilities in the future. More storage sheds produced today is an investment that means greater production in the future.

If the economy selects point A on the production possibilities curve, then there is no investment. The quantity of storage sheds produced is zero and all resources are used to make crab puffs. However, the economy can do a little investment if it selects point E. This production of storage sheds requires a sacrifice in the production of crab puffs, which can be illustrated by clicking the [A to E] button.

Further investment in storage sheds, and subsequent sacrifice of crab puffs, occurs if the economy selects point I rather than point E. A click of the [E to I] button will illustrate this alternative.

Risk and Growth

The obvious question that arises with the sacrifice of current satisfaction is: Why? Why would the economy, members of society, give up the production of consumption goods? Why would the people intentional make themselves worse off?

The answer is to achieve greater production in the future. The economy sacrifices some today to obtain more tomorrow. In fact, investment is the general process in which society expands, improves, and grows. Without investment, society stagnates and never improves. Without investment, there is no economic growth.

A critical dimension of this investment/growth process is risk and uncertainty of what the future might bring. A firm, for example, might invest in the construction of a new factory today anticipating that this will increase profit tomorrow. However, any number of things could go wrong to prevent the realization of the expected profit--government laws, changing market demand, or natural disasters, to name a few.

For this reason, investment invariably involves risk. Because no one knows what the future will hold, whenever a certain, known present is foregone for a future outcome, risk and uncertainty are involved.

More Than Factories

The essence of investment is giving up satisfaction today hoping for more tomorrow. The purchase of capital goods by the business sector is the "poster child" for investment by virtue of its critical role in the economy. But it is by no means the only type of investment.

Consider a short list of other, relatively important, examples of investment:

  • Education: One of the more important, nontraditional examples of investment is education, including both formal attending-a-school variety and informal on-the-job training. The result of education is the production of human capital--which makes labor more productive. However, to achieve this improvement in productivity, current consumption is sacrificed. In other words, a college student like Alicia Hyfield gives up an evening at the cinema to study for an exam.

  • Scientific Research: Closely related to education is the production of scientific research. In this case resources that could be used to produce wants-and-needs-satisfying goods are devoted instead to scientific activities. A scientist like Jacob Yorkenmeyer mixes chemicals rather than assembling a car. Scientific research and the resulting improvement in technology increases the productivity of labor, capital, and the other resources.

  • Public Infrastructure: Another, occasionally overlooked, example of investment is that undertaken by the government sector for public infrastructure. This capital includes transportation, communication, and energy distribution systems. These systems improve the productivity of the privately owned resources--especially labor and capital. Business firms like The Wacky Willy Company are more productive if they have easy access to modern, efficient streets, highways, and railroads used to ship their inputs and outputs.

  • Exploration: Another critical form of investment is the exploration for raw materials, such as petroleum reserves or mineral deposits. Knowing where these natural resources are located is the first step in their use. The generation of this knowledge, like education and scientific research, entails the sacrifice of wants-and-needs-satisfying production.

  • Household Production: The household sector undertakes a number of activities that may not be generally thought of as investment. The purchase of cars, appliances, furniture, and other durable goods offers an example. To the extent that these goods provide future satisfaction and involve the sacrifice of more immediate satisfaction, then investment takes place. However, taking the time to clean and organize a kitchen cabinet, bedroom closet, or garage, making it easier to cook, dress, or park a car, are also acts of investment.

Working the Financial Markets

Investment in capital goods is intertwined with financial markets. Firms in the business sector sell a wide assortment of legal claims to obtain the funds used to pay for capital goods. For this reason, returns in financial markets, especially interest rates, are closely connected to the expected profitability of capital.

Take the case of The Wacky Willy Company, which is considering the construction of a new factory to produce its popular Stuffed Amigos. The factory will entail an investment expense of $10 million. Once operating, it is expected to add $1 million per year to Wacky Willy profits, 10 percent of the initial investment. As such, The Wacky Willy Company is willing to pay an interest of up to 10 percent to borrow the $10 million of funds (by selling legal claims) used for the investment.

In competitive financial markets, with other firms also seeking to borrow investment funds, The Wacky Willy Company would be forced to pay this 10 percent interest rate to obtain the funds.

The bottom line (literally) is that the interest rates and other returns in financial markets directly reflect the profitability of investment in capital goods by the business sector.

Macroeconomic Instability

Business cycles are the recurring ups and downs of macroeconomic activity. The economy generally expands for several years, then it contracts for a year or two. While this macroeconomic instability can be triggered by a number of factors, the most important tends to be investment in capital goods by the business sector.

Because capital goods, like factories, buildings, and machinery, tend to take several years to produce and remains productive for several years, the business sector goes through periods where it buys a lot of capital goods, then very few. This results in periods of general economic expansion, then periods of general economic contraction.

Of the assorted expenditures on aggregate production by the economy--that by the household, business, government, and foreign sectors--investment expenditures on capital goods by the business sector is the least stable, or most volatile, and tends to be the biggest source of business cycles.

Investment Times Three

Three relatively distinct, but interrelated, notions of investment need to be differentiated.
  • Investment: This is the generic term for the sacrifice of current consumption to enhance future production capabilities. Such investment can involve the business acquisition of capital goods or activities undertaken by the household sector, such as attending college.

  • Investment expenditures: This is the more specific term referring to actual expenditures on goods and services, or gross domestic product, by the business sector. Investment expenditures specifically deal with investment activities that involve business purchases of capital goods. Not all generic investment activities involve investment expenditures on gross domestic product.

  • Gross private domestic investment: This is the official measure of the investment expenditures component of aggregate expenditures used in the calculation of gross domestic product.


Recommended Citation:

INVESTMENT, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2024. [Accessed: May 23, 2024].

Check Out These Related Terms...

     | investment expenditures | investment borrowing | consumption expenditures | consumption | saving | government purchases | net exports |

Or For A Little Background...

     | macroeconomics | business sector | production | financial markets | capital | satisfaction |

And For Further Study...

     | business cycles | macroeconomic problems | circular flow | economic growth | economic goals | macroeconomic sectors | macroeconomic markets | macroeconomic theories | science | investment, production possibilities | economic growth, production possibilities | competitive market | investment business cycles | capital stock, aggregate supply determinant |

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