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Investment is the practice or operation of saving money on something that will yield a benefit. In an economic context, it can also be characterized as the buying of goods for future use in the production of capital (Luenberger, 2013 p.35).
The desire and ability of a customer to own a product or enjoy a service, on the other hand, can be described as demand. Since investment is a component of aggregate demand, it is essential in understanding aggregate successful demand. Investment connects the present to the future by making an investment in already available capital in order to reap future gains in terms of profit and wealth (p.11). Investment is determined by the purchase of capital goods at a given time based on the financial conditions present the expected profit in future (p. 11).
There are two price systems in investment. The first price system is the asset price which refers to the amount one pays for an asset when acquiring it. Asset price is based on the expected yield of an asset and its appropriate interest rate. The second price system is the goods price which refers to the amount one pays for goods that are consumed or used regularly. Goods price is based on cost added to the profit margin. These two price systems are then linked by capital goods which are produced assets (p. 13).
Aggregate demand refers to the entire demand for final goods and services at a given time in an economy. Effective aggregate demand occurs when there is a current demand for a product or service in the market by constrained purchasers. Investment is intertwined with demand as it takes place so long as the demand price is greater than the supply price (p.14). As earlier mentioned, investment involves spending cash on something that will yield good returns at a future date. Aggregate demand for a good should be highly priced as compared to the supply price.
The demand price for capital goods is what a firm or investor would be willing to pay based on the expected returns. The supply price of capital goods, on the other hand, is what it costs to buy from a producer. The demand price of a product depends on a number of factors. One of the factors is long-term interest rate. If the interest rate is high and maintained then the demand price becomes high. This means that a firm or more people will want to invest in the given product so as to get the high returns in due time. The other factor is profit expectations. When profits for a given product are expected to be high then its demand price will be high, raising the cost of investment (p. 23).
When investing, a firm’s perception and attitude towards risk affects the demand price. If a firm's projection of the future plans and investments show a huge risk of loss or profit, the demand price is affected. If the chances of gaining by a huge margin are high then the demand price becomes high and vice versa. The supply price, on the other hand, depends on the cost of production and markup. When looking at what to invest in, a firm looks at the recent and current profits. This translates to the internal funds a firm has after taking care of all other business-related costs.
Investment is important in understanding effective aggregate demand also because of the lending aspect in investment. When investing, a firm or an individual may use their savings, contributions from friends and family, or money from lending institutions. Demand for a certain product or service is, among other things, determined by the purchaser’s ability to afford. This brings in the point of lender perception towards risk in determining the supply cost of a product, which in turn affects its demand and demand price (p. 23).
Investment is affected by boom and bust markets. In a boom market, there exist high expectations due to high profits. The boom market is also characterized by a lot of internal funds, low perception of risk by the firm, and lending institutions. In a bust market, the available funds are less and there is usually a high perception of risk by the firm and lending institutions (p. 24). During a boom market, demand for certain goods and services is usually high, and as a result, profits increase as well as internal funds. However, a boom can be killed by saturation in the market or overinvestment. This, in turn, lowers the demand and profit.
When talking about investment and demand, employment is also a major factor. This is because individuals are also involved in investing and demanding certain goods and services. The power of investment and demand lies in the ability to afford a good or service. Employment provides an income to employees who are then able to purchase goods or pay for services. The need to purchase a good or pay for a service gives rise to demand. According to the basic kaleckian model (p. 31), income is a result of wage multiplied by employment and added to profits (income = wage x employment + profits). This then equates to consumption plus investment.
Demand rises when there are more people in employment and getting a wage or salary. When the wages and salaries of employed people drop, then the demand for various goods and services may drop due to the lack of purchasing power. This, in turn, translates to lower investments, especially for products with a high demand price. It is therefore important to note that investment is directly affected by demand. If an investment is projected to make good returns in the future, then its demand will increase despite it having a high price. If an investment is projected to have low returns, then its demand price may be lower (Luenberger, 2013 p. 54).
‘Demand and Investment’, Lecture Notes, PowerPoint Presentation
Luenberger, D. G. (2013). Investment Science. Oxford University: Oxford University Press.
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