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Deconstructing the GDP - Investment

In the equation constructing the GDP ( Y = C + I + G + NX ), the "I" stands for investment. Capital is extremely important to a country's ability to make output. A country's capital increases as more things are bought.

Capital also wears out as it is used. Time takes it's toll. Machinery rusts, things break down to a permanent degree and are replaced and some things are just simply thrown away. Some things simply become obsolete and are replaced. When things are purchased they begin to depreciate. Investments that are greater than depreciation mean a more modern infrastructure and more potential output is capable for people to consume.

Interest rates determine to a large degree whether or not companies will buy equipment. If interest rates are too high it makes no sense to purchase items when loan repayment costs are high. If a company has enough cash on hand to buy items, it has to evaluate whether it's actually worth it to buy items (some of which are discretionary) or to use it somewhere else. If interest rates are high, loaning out money makes more sense than high loan repayment costs and a company may choose to forgo capital expenditures.

Simply put, if interest rates are high then investment is discouraged.


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This page contains a single entry from the blog posted on December 14, 2008 11:41 AM.

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