What is capital consumption, and why must it be subtracted to arrive at net investment?

Capital consumption, or depreciation, is the value of the existing capital stock used up during the period through wear and tear and obsolescence. Some of each year's gross investment merely makes good that loss and leaves the economy no better equipped than before. Subtracting it isolates the genuine addition to productive capacity.

Gross investment is 380 billion pounds and capital consumption is 265 billion pounds. Calculate net investment and interpret the result.

Net investment = 380 - 265 = 115 billion pounds. The capital stock has grown by 115 billion pounds over the year, so the economy has more machinery, buildings and infrastructure than it started with. Its productive capacity, and therefore long-run aggregate supply, should be higher as a result.

In a different year gross investment is 380 billion pounds while capital consumption is 395 billion pounds. Calculate net investment and explain what this implies.

Net investment = 380 - 395 = minus 15 billion pounds. Firms are not even replacing the capital that is wearing out, so the capital stock is shrinking. Positive gross investment therefore disguises a fall in productive capacity, which will constrain output in future years even though current spending is still adding to aggregate demand.

What is gross fixed capital formation, and what does it exclude?

Gross fixed capital formation is spending on durable produced assets that will be used repeatedly in production for more than a year: buildings, plant and machinery, vehicles, infrastructure, and intangibles such as software and research. It excludes changes in stocks of raw materials, work in progress and unsold goods, which are not fixed assets, and it excludes purchases of land and of second-hand assets, since no new capital is produced.

CCEA A-Level Economics 4410

Key Economic Concepts

Topic overview The four factors of production Positive statements and normative judgements Economic agents and what they are trying to achieve Capital goods and consumption goods Product markets and factor markets

The Basic Economic Problem of Scarcity and Choice

Topic overview Scarcity, choice and opportunity cost Drawing and reading the production possibility frontier Using a PPF to show choice, opportunity cost, efficiency and growth Why an economy operates inside its frontier Specialisation and the division of labour Free market, planned and mixed economies

Demand and Supply in Product Markets

Topic overview What determines demand and what determines supply Movements along a curve versus shifts of a curve Why the demand curve slopes downwards Why the supply curve slopes upwards: marginal cost and the profit incentive Consumer surplus and producer surplus When consumers do not behave rationally

Markets and Equilibrium

Topic overview Market equilibrium and how markets clear How shifts in demand and supply change the equilibrium Price signals, incentives, rationing and the role of profit Joint, composite and derived demand and joint supply Tracing effects between interrelated markets Community surplus and allocative efficiency Demand and supply in housing, energy and commodity markets Indirect taxes and subsidies: impact and incidence

Elasticity of Demand and Supply

Topic overview Price elasticity of demand: measuring and interpreting Income and cross elasticity: normal, inferior, substitutes and complements Price elasticity of supply What determines the value of an elasticity Elasticity and total revenue How useful is elasticity for firms and government?

Factor Markets: Labour

Topic overview How a competitive labour market sets the wage Elasticity of labour demand and labour supply Wage differentials and why they persist Economic rent and transfer earnings Flexibility: trade unions, welfare and migration Minimum wages and government intervention in the labour market

Market Failures and Imperfections

Topic overview Market equilibrium, the social optimum and the meaning of market failure Externalities: private, external and social costs and benefits Community surplus and the externality diagrams Calculating and interpreting welfare loss Public goods, quasi-public goods and the free rider problem The consequences of missing markets for public goods Merit goods and demerit goods Information gaps and asymmetric information The consequences of merit goods, demerit goods and information failure Market power and other market imperfections Income and wealth inequality Absolute and relative poverty

Government Intervention in Markets

Topic overview Why governments step into markets Indirect taxes Subsidies, and choosing between taxes and subsidies Maximum and minimum prices State provision Regulation Information provision Tradeable pollution permits Government failure

The Circular Flow of Income

Topic overview Households, firms and the two-way flow Injections and withdrawals in an open economy with government Equilibrium and change in the circular flow

Measuring National Income

Topic overview Three routes to the same total: income, expenditure and output GDP as a measure of welfare and its limitations Domestic or national? GDP and GNP compared Nominal and real values: correcting for price changes Total and per capita measures

Aggregate Demand

Topic overview The four components of aggregate demand Why the aggregate demand curve slopes downwards Movements along and shifts in aggregate demand Factors that shift aggregate demand Investment: gross, net and fixed capital

Aggregate Supply

Topic overview Why short-run aggregate supply slopes upwards Factors that shift short-run aggregate supply Movements along and shifts in aggregate supply From the short run to the long run What determines long-run aggregate supply Keynesian and neoclassical views of long-run aggregate supply

Macroeconomic Equilibrium

Topic overview How aggregate demand and aggregate supply determine equilibrium Applying AD-AS analysis to growth and unemployment Applying AD-AS analysis to inflation

Macroeconomic Objectives

Topic overview Why governments target inflation, unemployment, the external balance and growth Objectives beyond the main four: the environment and the distribution of income and wealth Picturing inequality: the Lorenz curve and the Gini coefficient Where the objectives collide: the main policy conflicts Judging the trade-offs: how sharp is a conflict?

Inflation

Topic overview Inflation, deflation and disinflation: what the words actually mean Measuring the rate: the CPI and the RPI Working with index numbers Building a price index: the basket and the significance of weights Demand-pull and cost-push inflation The costs and consequences of inflation and deflation The policy response to inflation

Unemployment

Topic overview The claimant count and the ILO measure of unemployment Calculating and interpreting unemployment statistics Unemployment and economic inactivity: a distinction that changes the numbers The types of unemployment and what distinguishes them The causes of unemployment and of economic inactivity The costs and consequences of unemployment and inactivity Policies for unemployment and intervention in the labour market

Economic Growth

Topic overview Actual and potential growth on a production possibility frontier Measuring economic growth The economic cycle and output gaps The causes of economic growth Benefits, costs and the sustainability of growth Policies to promote economic growth using AD–AS analysis

Fiscal Policy and Its Effects

Topic overview What fiscal policy is and how it works Government spending and taxation: the main categories Direct and indirect taxation Fiscal policy in the AD-AS model Evaluating the impact of fiscal policy on output, employment, prices and agents

Monetary Policy

Topic overview The nature of monetary policy and the interest rate instrument The transmission mechanism from interest rates to aggregate demand Monetary policy in the AD-AS model Evaluating the impact of monetary policy on output, employment, prices and agents

Supply-Side Policies

Topic overview The nature of supply-side policy and tax cuts Deregulation and evaluating market-based supply-side policy Competition and innovation as supply-side policy Infrastructure as supply-side policy Labour market reform Education, training and the skills of the workforce Labour productivity: determinants and significance Supply-side policies in the AD-AS model Evaluating the impact of supply-side policies

Exchange Rates and the National Economy

Topic overview What an exchange rate is and how it is measured Exchange rate changes in the AD-AS model Holding the exchange rate above or below the market clearing level Why a government might have an exchange rate policy Evaluating the impact of exchange rate changes on output, employment, prices and agents

Short Run Versus Long Run

Topic overview The short run, the long run and the law of diminishing returns Fixed, variable and total costs of production Calculating and drawing the short-run cost curves Revenue curves: total, average and marginal revenue The profit-maximising output Shutdown, breakeven, and normal and supernormal profit Long-run cost, economies of scale and minimum efficient scale Efficiency, X inefficiency and the effects of firm size

Business Objectives

Topic overview Why firms pursue maximum profit Alternative objectives: revenue, growth, managerial utility, satisficing and the environment Ownership, control and the principal-agent problem Stakeholders, and public versus private sector objectives

Business Growth

Topic overview How and why firms grow, and why some stay small Organic growth versus merger and acquisition Horizontal, vertical and conglomerate integration Evaluating the motives for and consequences of growth

Measuring Markets

Topic overview Market size, market share and market growth The n firm concentration ratio Difficulties in measuring market share accurately Sales value against sales volume

Analysing Market Structures

Topic overview What defines a market structure Price and output across the structures Efficiency across the market structures Market structure and innovation How useful are the models of market structure?

Perfect Competition

Topic overview The price taker's revenue curves and short-run equilibrium The firm and the industry side by side How the market moves from the short run to the long run

Monopoly

Topic overview Barriers to entry Monopoly equilibrium and its consequences Price discrimination Natural monopoly Creative destruction

Monopolistic Competition

Topic overview The firm's demand curve when products are differentiated Short-run equilibrium for the firm Long-run equilibrium and excess capacity How the market moves from the short run to the long run

Oligopoly

Topic overview Concentration and interdependence: what marks out an oligopoly Collusion and price leadership Price wars and sustaining collusion Non-price competition and product differentiation The kinked demand curve model Game theory and the pay-off matrix Evaluating the costs and benefits of oligopoly

Contestable Markets

Topic overview What makes a market contestable Sunk costs and hit-and-run entry How ease of entry changes the behaviour of firms Judging contestability and its significance

Competition Policy

Topic overview The aims and shape of competition policy Breaking up firms and controlling mergers Regulation, regulators and price caps Evaluating regulation and its alternatives Taxation and subsidies as competition remedies Nationalisation Privatisation, and choosing between public and private ownership Banning unfair trading practices Judging competition policy and government failure

Trade and Globalisation

Topic overview Calculating absolute and comparative advantage Evaluating comparative advantage and its limits The gains and losses from free trade Globalisation and its effects Foreign direct investment The instruments of protectionism Evaluating protectionism The World Trade Organisation Trading blocs, trade creation and trade diversion

Economic Development

Topic overview What economic development means and how it differs from growth The difficulties of measuring development National income statistics and comparisons of living standards The Human Development Index Growth in less developed countries: benefits, costs and constraints Promoting development: aid, institutions, debt and trade

Balance of Payments

Topic overview How the balance of payments is put together Consequences of current account deficits and surpluses Policies to correct current account imbalances Expenditure-switching and expenditure-reducing policies

Exchange Rate Systems and Competitiveness

Topic overview How foreign exchange markets operate The influences on currency demand and supply Monetary policy, intervention and other influences on the exchange rate Fixed and floating exchange rate systems The Marshall-Lerner condition and the J-curve The effect of exchange rate changes on the current account Trade-weighted exchange rate indices Purchasing power parity and comparing competitiveness Evaluating exchange rate policy

European Union (EU)

Topic overview The economic case for membership of a trading bloc The costs and constraints of membership, and the position of candidate countries Enlargement, withdrawal and changes in the structure of the union The Eurozone: one currency and one interest rate

Monetary Policy and the Financial Sector

Topic overview Central banks, the banking sector and the money supply Setting the base rate and the transmission of monetary policy The Fisher equation of exchange and the quantity theory of money The financial sector and the real economy Moral hazard in banking Regulating the financial system Regulation and the money supply in a global economy Quantitative easing The money supply and monetary policy in an open economy The effectiveness of monetary policy

Fiscal Deficits and the National Debt

Topic overview The deficit and the debt: a flow and a stock What determines the size of a fiscal deficit Discretionary policy and automatic stabilisers Financing the deficit: bonds, borrowing and crowding out The benefits and costs of a deficit and of the national debt Fiscal policy, macroeconomic objectives and economic agents

Macroeconomic Policies and Objectives in a Global Economy

Topic overview Comparing the performance of different economies Global events and how they reach the domestic economy Responding to external demand and supply shocks Problems and constraints facing policymakers How the priority given to macroeconomic objectives has changed Comparing policies against one another

Quantitative Skills in Economics

Topic overview Ratios, shares and proportions in economic data Percentages and percentage changes in economic data Averages, medians and quantiles Index numbers, weighting and rebasing Converting money values to real values Cost, revenue and profit Elasticity: calculating the number and reading its meaning Choosing and reading economic charts and diagrams Interpreting economic data critically

Aggregate Demand

Investment: gross, net and fixed capital

3 things to know
Unit AS 2

Overview

Gross investment and net investment, capital consumption and gross investment be rising while the capital stock is falling.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Key term

Define gross investment and net investment, and state the relationship between them.

Key term

Distinguish between fixed capital and working capital.

Key term

Analyse the factors, other than interest rates, that determine the level of investment in an economy.

Questions from this subtopic

Each one with the model answer underneath.

1
Define gross investment and net investment, and state the relationship between them.
Model answer
Gross investment is total spending on capital goods in a period, including both additions to the capital stock and the replacement of capital that has worn out. Net investment is gross investment minus capital consumption, that is depreciation. Net investment is therefore the amount by which the capital stock actually grows over the period.
2
What is capital consumption, and why must it be subtracted to arrive at net investment?
Model answer
Capital consumption, or depreciation, is the value of the existing capital stock used up during the period through wear and tear and obsolescence. Some of each year's gross investment merely makes good that loss and leaves the economy no better equipped than before. Subtracting it isolates the genuine addition to productive capacity.
3
Gross investment is 380 billion pounds and capital consumption is 265 billion pounds. Calculate net investment and interpret the result.
Model answer
Net investment = 380 - 265 = 115 billion pounds. The capital stock has grown by 115 billion pounds over the year, so the economy has more machinery, buildings and infrastructure than it started with. Its productive capacity, and therefore long-run aggregate supply, should be higher as a result.
4
In a different year gross investment is 380 billion pounds while capital consumption is 395 billion pounds. Calculate net investment and explain what this implies.
Model answer
Net investment = 380 - 395 = minus 15 billion pounds. Firms are not even replacing the capital that is wearing out, so the capital stock is shrinking. Positive gross investment therefore disguises a fall in productive capacity, which will constrain output in future years even though current spending is still adding to aggregate demand.
5
How can gross investment be rising while the capital stock is falling?
Model answer
The capital stock changes by net investment, not gross investment. If depreciation exceeds gross investment, the stock falls even though spending on capital goods is positive and increasing. This can happen when a large amount of existing capital reaches the end of its life at once, or when rapid technological change makes machinery obsolete faster than it is replaced.
6
What is gross fixed capital formation, and what does it exclude?
Model answer
Gross fixed capital formation is spending on durable produced assets that will be used repeatedly in production for more than a year: buildings, plant and machinery, vehicles, infrastructure, and intangibles such as software and research. It excludes changes in stocks of raw materials, work in progress and unsold goods, which are not fixed assets, and it excludes purchases of land and of second-hand assets, since no new capital is produced.

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Key Economic Concepts

The Basic Economic Problem of Scarcity and Choice

Demand and Supply in Product Markets

Markets and Equilibrium

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AThe initial spending becomes income for those who receive it.

BPart of that income is spent again, generating further income.

CThe total effect on demand exceeds the original injection.

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Investment: gross, net and fixed capital

Overview

What you need to know

Define gross investment and net investment, and state the relationship between them.

Distinguish between fixed capital and working capital.

Analyse the factors, other than interest rates, that determine the level of investment in an economy.

Questions from this subtopic

Define gross investment and net investment, and state the relationship between them.

What is capital consumption, and why must it be subtracted to arrive at net investment?

Gross investment is 380 billion pounds and capital consumption is 265 billion pounds. Calculate net investment and interpret the result.

In a different year gross investment is 380 billion pounds while capital consumption is 395 billion pounds. Calculate net investment and explain what this implies.

How can gross investment be rising while the capital stock is falling?

What is gross fixed capital formation, and what does it exclude?

Other ways to work this

What is inside Levo

The 3-step method, run for you

Cram a whole paper in one sitting

Blank Blitz makes facts automatic

Build It gets the exam shape right

Test It catches misconceptions

Brain Breaks between sessions

Every question in Aggregate Demand, on a schedule.