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Investment and Economic Growth

24 April, 2015 - 17:37

Investment adds to the stock of capital, and the quantity of capital available to an economy is a crucial determinant of its productivity. Investment thus contributes to economic growth. We saw in Figure 29.4 that an increase in an economy’s stock of capital shifts its production possibilities curve outward. (Recall from the chapter on economic growth that it also shifts the economy’s aggregate production function upward.) That also shifts its long-run aggregate supply curve to the right. At the same time, of course, an increase in investment affects aggregate demand, as we saw in Figure 29.6.

KEY TAKEAWAYS

  • Changes in investment shift the aggregate demand curve to the right or left by an amount equal to the initial change in investment times the multiplier.
  • Investment adds to the capital stock; it therefore contributes to economic growth

TRY IT!

The text notes that rising investment shifts the aggregate demand curve to the rightand at the same time shifts the long-run aggregate supply curve to the right by increasing the nation’s stock of physical and human capital. Show this simultaneous shifting in the two curves with three graphs. One graph should show growth in which the price level rises, one graph should show growth in which the price level remains unchanged, and another should show growth with the price level falling.

Case in Point: Investment by Businesses Saves the Australian Expansion

With consumer and export spending faltering in 2005, increased business investment spending seemed to be keeping the Australian economy afloat. “Corporate Australia is solidly behind the steering wheel of the Australian economy,” said Craig James, an economist for Commonwealth Securities, an Australian Internet securities brokerage firm. “The clear message from the latest investment survey is that corporate Australia is flush with cash and ready to spend,” he continued.

The data supported his conclusions. The level of investment spending in Australia on new buildings, plant, and equipment was 17% higher in 2005 than in 2004. Within the investment category, mining investment, spurred on by high prices for natural resources, was particularly strong.

Source: Scott Murdoch, “Equipment Investment Gives Boost to Economy,” Courier Mail (Queensland, Australia), September 2, 2005, Finance section, p.35.

ANSWER TO TRY IT! PROBLEM

  1. Panel (a) shows AD shifting by more than LRAS; the price level will rise in the long run.
  2. Panel (b) shows AD and LRAS shifting by equal amounts; the price level will remain unchanged in the long run.
  3. Panel (c) shows LRAS shifting by more than AD; the price level falls in the long run.

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