The Importance of Investment

Investment is of crucial importance because the capacity of production of the economy depends on the capital available to produce. The existences of capital increase when the companies buy new tools, new buildings, new computers, new machines etc, etc, in order to help produce consumption goods. Investment is a flow that increases the existence of capital in the economy. But, of course capital runs out when it is used. One part becomes rusted; another part gets damaged, while there is another that is thrown out when it is no longer useful. Economists call all of the flows that reduce the existence of capital, depreciation.

Obviously companies need to make some investments alone to replace the capital that has depreciated. However any other investment above depreciation makes the size of the existence of capital to increase, creating a greater product potential so that people consume it. The flow of investment expenditure in any period of time depends on the comparisons the companies do between the potential benefits and the costs of buying capital goods. The potential benefits are measured in terms of the potential yield, and the buying costs are measured by the interest rate, no matter if a company asks for a loan or doesn’t in order to buy a given capital unit.

Why is the interest rate so important? If a company needs to ask for a loan in order to buy capital, it is obvious that the higher interest rates make it less probable that you will ask for money because paying off the debt would be more expensive. However, even if a company does have enough money in cash to buy a given unit of equipment, higher interest rates force the company to decide if they should use the cash to buy the equipment of borrow it from someone else. The higher the interest rates, the more attractive it is to give out the cash as a loan. As a consequence, higher interest rates discourage investment no matter if the companies have to ask for borrowed money in order to finance it.