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Asset Allocation Asset allocation refers to the division of one's investment portfolio across the various asset classes. At the highest level, this refers to a split between stocks and bonds. Many more finely defined sub-asset allocations are also common. Ian Ayres and Barry J.

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Investment spending is an injection into the circular flow of income. Firms invest for two primary reasons: Firstly, investment may be required to replace worn out, or failing machinery, equipment, or buildings.

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This is referred to as capital consumption, and arises from the continuous depreciation of fixed capital assets. Secondly, investment may be undertaken to purchase new machinery, equipment, or buildings in order to increase productive capacity.

This will reduce long-term costs, increase competitiveness, and raise profits. Gross investment includes both types of investment spending, but net investment only measures new assets rather than replacement assets. This relationship is expressed in the following equation: In economic theory, net investment carries more significance, as it provides the basis for economic growth.

The determinants of investment The level of investment in an economy tends to vary by a greater extent than other components of aggregate demand.

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This is because the underlying determinants also have a tendency to change. The main determinants of investment are: This means that businesses, entrepreneurs, and capital owners will require a return on their investment in order to cover this risk, and earn a reward.

In terms of the whole economy, the amount of business profits is a good indication of the potential reward for investment. Business confidence Similarly, changes in business confidence can have a considerable influence on investment decisions.

Uncertainty about the future can reduce confidence, and means that firms may postpone their investment decisions until confidence returns. Changes in national income Changes in national income create an accelerato r effect. Economic theory suggests that, at the macro-economic level, small changes in national income can trigger much larger changes in investment levels.

The determinants of investment

Interest rates Investment is inversely related to interest rates, which are the cost of borrowing and the reward to lending. Investment is inversely related to interest rates for two main reasons. Firstly, if interest rates rise, the opportunity cost of investment rises.

This means that a rise in interest rates increases the return on funds deposited in an interest-bearing account, or from making a loan, which reduces the attractiveness of investment relative to lending.

Hence, investment decisions may be postponed until interest rates return to lower levels. Secondly, if interest rates rise, firms may anticipate that consumers will reduce their spending, and the benefit of investing will be lost. Investing to expand requires that consumers at least maintain their current spending.

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Therefore, a predicted fall is likely to discourage firms from investing and force them to postpone their investment decisions. Any indication of a downturn in the economy, a possible change of government, war or a rise in oil or other commodity prices may reduce the expected benefit or increase the expected cost of investment.

Corporation tax Firms pay corporation tax on their profits, so a reduction in tax increases the profits they retain after tax is paid, and this acts as an incentive to invest.Browse M+ essays, research and term papers to jumpstart your assignment.

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