Question
Briefly explain the following basic concepts related to NI:
Gross Investment and Net Investment
Solution
Gross Investment and Net Investment
Investment means addition to the stock of capital goods such as structures, equipment or inventory that adds to the future productive capacity of the economy. It implies creation or addition of physical assets which are used to augment the productive capacity of the economy in future. This should not be confused with layman's notion of investment which generally denotes purchase of shares or financial assets. Remember in economic analysis, investment always means capital formation — a gross or net addition to capital stock of the economy.
Gross investment. That part of total final output which comprises of capital goods like machinery, plants, buildings constitutes gross investment of an economy. It is addition to the capital stock which also includes replacement cost for the wear and tear that the capital stock undergoes over a period of time. When investment is expressed as gross investment, it includes depreciation.
Depreciation. Depreciation means loss in the value of fixed asset due to its normal wear and tear in the process of production. We know that fixed capital like machine, tools, building, rail engine, 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. When the assets wears out completely, it needs replacement. 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 life time of asset is used to replace the asset 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.
Net investment. By deducting depreciation from gross investment, we get net investment. Symbolically:
Net investment = Gross investment - Depreciation
Remember, new addition to the capital stock in the economy is measured by net investment (and not by gross investment).
Investment means addition to the stock of capital goods such as structures, equipment or inventory that adds to the future productive capacity of the economy. It implies creation or addition of physical assets which are used to augment the productive capacity of the economy in future. This should not be confused with layman's notion of investment which generally denotes purchase of shares or financial assets. Remember in economic analysis, investment always means capital formation — a gross or net addition to capital stock of the economy.
Gross investment. That part of total final output which comprises of capital goods like machinery, plants, buildings constitutes gross investment of an economy. It is addition to the capital stock which also includes replacement cost for the wear and tear that the capital stock undergoes over a period of time. When investment is expressed as gross investment, it includes depreciation.
Depreciation. Depreciation means loss in the value of fixed asset due to its normal wear and tear in the process of production. We know that fixed capital like machine, tools, building, rail engine, 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. When the assets wears out completely, it needs replacement. 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 life time of asset is used to replace the asset 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.
Net investment. By deducting depreciation from gross investment, we get net investment. Symbolically:
Net investment = Gross investment - Depreciation
Remember, new addition to the capital stock in the economy is measured by net investment (and not by gross investment).
