Investment and Economic Growth

May 6th, 2008 | economics -

Readers Question: Discuss Importance of Investment in Increasing Economic Growth.

Investment is a component of AD. Therefore, if there is an increase in investment it will help to boost AD and therefore economic growth.

If there is spare capacity then a rise in AD will increase economic growth. However, if the economy is close to full capacity, then rising AD will only cause inflation and not an increase in real GDP

Also, it is important to bear in mind that there are other factors that affect AD apart from investment. Therefore, if there was a fall in consumer spending or exports then a rise in investment may not actually increase AD. Investment is not the biggest component of AD, that is C.

If investment is effective then it should increase the productive capacity of the economy. For example, investing in skills and education can increase labour productivity. Investment in new technology and capital can increase the productive capacity of the economy. This helps to shift AS to the right. An increase in AS can increase long term economic growth; it can increase growth without inflation. If investment leads to a significant increase in productivity then it can lead to an increase in the long run trend rate of economic growth.

It depends on the type of investment. For example, government investment in improving industry could be totally inefficient and fail to increase productivity in the economy. However, private sector investment, or investment from oversees may be much more effective in actually increasing productivity.