The previous page introduced investment from a broad perspective, and whereas this article will also follow the conception of investment from an economics point of view, it hopes to look at the topic in slightly greater detail.
As a reminder: economists view investment as the production of goods that will be used to generate (through a variety of means) other goods. Popular usage, however, refers to investment as the purchasing of stocks and bonds.
On the above economics view, investment can include non-physical goods like human capital. For example, a young person who decides to attend university in order to obtain a degree is investing in his/her future: whereas the individual in question will forego the opportunity to earn wages immediately, their thinking is that the sacrifice of immediate employment will lead to better employment opportunities in the future (that is, either a better or higher paying job).
Closely allied to investment is the notion of opportunity cost: the term refers to the total price which is paid for a product. The idea of opportunity cost is, however, more inclusive than monetary price, and includes elements like time. As can be inferred, the opportunity cost of investment is current consumption (the price of investment is those resources used for investment). The opportunity cost of the student example is current employment and wage expenditure. The value gained from investment, however, is estimated by the individual to be greater than the value of the opportunity cost of the investment. This is to say that, as in any buying dynamic, the buyer sees a greater value (utility) in the product being purchased than in its opportunity cost.
In the macro-economy, investment expenditure (in monetary terms) is measured as part of the total GDP of an economy. This model is widely used by Keynesian economists and is described as follows: GDP=C+I+G. This means that total economic output (GDP) is dependent on consumption spending, investment spending, and government spending. As the GDP is also seen as the addition of consumption spending, savings and spending on taxes (GDP=C+S+T), S+T=I+G (savings plus taxes equals investment spending and taxes). If the government can only spend the tax money it collects, then investment spending is equal to savings: S=I. Investment is thus dependent on the saving of wealth, and maximum investment will occur when consumption is reduced to bare essentials and government taxes are low.
Other factors directly influencing investment levels are income levels and interest rates. The higher the income level of both, an individual as well as an entire economy, the higher the savings amount will be; secondly, the higher the interest rate, the higher the returns on lending money. The latter works as follows: interest rates should be seen as the cost of money – in this case the person who sells the money (the investor) gets a higher price for money when interest rates are high. The lower the interest rates, the cheaper it is to buy money.
Thus, it is good practice to lend money (invest) when interest rates are high, and good to borrow money when interest rates are low. The institutions that borrow money (investees) use the funds to grow their businesses or invest in new capital stock (new equipment, facilities, etc.) expecting that the price they pay for the investment funding will be lower than the profits to be gained from investing. This calculation will necessarily include the cost of borrowing money, and thus lower interest rates will induce more companies to borrow for investment purposes.
Technically speaking, however, whereas companies using money to purchase capital stock (machinery, etc.) could be seen to be investing (if they have collateral to back the amount borrowed), the institutions providing financing are mostly speculating as they assume a certain of risk that the borrow of the money will not be able to pay them back the full initial amount plus the interest accumulated on that amount.