Short Notes on Investment on a Product!
Investment implies creation or addition of physical assets which are used to increase the productive capacity of the economy in future.
This should not be confused with layman’s notion of financial investment which generally denotes purchase of stocks, shares or financial assets.
Remember, in economic analysis, investment always means capital formation, i.e., addition to the physical stock of capital goods like building of new factories, machines, equipment, etc.
That part of total final output which comprises capital goods constitutes gross investment of an economy. It is addition to the capital which also includes replacement cost for the wear and tear that capital stock undergoes over a period of time. When investment is expressed as gross investment, it includes depreciation. What is depreciation?
It means loss of value of fixed asset (like building, machinery) due to its normal wear and tear in the process of production. We know that fixed capital such as machines, tools, buildings, rail engines, etc. wear out over time when repeatedly used leading to fall in value. This depreciation or fall in value due to normal wear and tear is called consumption of fixed capital.
Therefore, every enterprise makes annual provision of funds called depreciation provision to the tune of estimated value of depreciation. The fund thus accumulated over the lifetime of asset is used to replace it when it wears out completely. That is why depreciation is also sometimes called current replacement cost. In short, gross investment is inclusive of depreciation (or consumption of fixed capital).
By deducting depreciation from gross investment, we get net investment.
Net investment = Gross investment – Depreciation
Note that new addition to the capital stock in the economy is measured by net investment (and not by gross investment).