Investment

4.1.2 Investment

Investment, in economics, means something very specific: it is the addition to the economy’s stock of physical capital. This includes machines, buildings, roads, bridges, and any other durable good that adds to the economy’s future productive capacity. It also includes changes in the inventory (the stock of finished goods) that a producer holds.

A common confusion is to think of investment as buying shares or depositing money in a bank. In macroeconomics, those are financial transactions, not investment. Investment here is always about real, physical assets that produce goods and services.

Investment goods are themselves final goods. A machine produced in a given year is not “used up” like raw materials (intermediate goods). Instead, it yields its services over many years. That is why it is counted as part of final expenditure in GDP.

The decision to invest — whether to buy a new machine or build a new factory — depends heavily on the market rate of interest. A higher interest rate makes borrowing more expensive and reduces the incentive to invest. A lower interest rate does the opposite. However, for the purpose of building a simple model of income determination, the textbook makes a simplifying assumption: firms plan to invest the same amount every year, regardless of the current level of income or the interest rate.

This kind of investment is called autonomous investment. It is independent of the level of income. The textbook writes the ex ante (planned) investment demand as:

Here, $\bar{I}$ (read as “I-bar”) is a positive constant. It represents the fixed, autonomous investment that firms plan to undertake in a given year. The bar over the symbol is a standard notation in economics to indicate that the variable is exogenous — determined outside the model, not explained by the model itself. …