Is Replacement Investment

Is Replacement Investment – Appreciate the importance of investment and capital accumulation for output growth. Understand the investment determinants. Understand the short- and long-term implications of investing for the business cycle. Understand government policy towards investment. Concepts: Fixed Capital Investment Total and Net Investment Human Capital Variable Productivity Discount Capital to Output Ratio Guaranteed Growth Rate 23/2/2019 Dr. Mansour Al Bataineh

4 WHAT IS INVESTMENT? The acquisition of additional capital (capital accumulation). Capital is something that benefits now and in the future. Capital reserve of the economy is formed over time through investment capital flows. Some of these investments merely replace amortized capital, and some of these investments add to the capital in the economy. In terms of income flows (Chapters 8 and 11), some of the income from the current period is retained by households as savings and reserved for businesses to expand production in subsequent periods. . Thus, investment is the part of current income that is not consumed but used to expand the productive capacity of the economy. February 23, 2019 Dr. Mansour Al Batainh

Is Replacement Investment

Depreciation is used to measure the decline in the contribution of existing capital over time. Capital replacement investment denotes the purchase of new physical capital to replace worn out physical capital. Such investment ensures that the amount of capital available to companies remains constant. Companies will need to update their capital to maintain output and productivity levels relative to industry ‘best practices’. Such alternative investment will often also involve upgrading existing capital to allow for increased output and productivity (capital enhancement investment). Pooled investments include both alternative and capital-enhancing investments, and are made to expand production capacity through equity capital appreciation. February 23, 2019 Dr. Mansour Al Batainh

Expansion Projects, Replacement Projects And Depreciation

6 NET INVESTMENT: refers only to capital enhancement investment and is calculated as total investment minus replacement investment (depreciation). When net investment in the economy is zero, the economy maintains only its capital stock. The effect of positive net investment is to increase the amount of capital available to firms. February 23, 2019 Dr. Mansour Al Batainh

First, net investment can lead to an increase in the scale of production and thus an increase in productivity due to economies of scale. Second, there can be an increase in capital intensity in production – that is, more capital is used per worker. Third, net investment is new investment, which can technologically outperform existing capital, thereby increasing overall productivity. Increasing productivity in manufacturing is important because it allows the economy to achieve a higher level of output with the same resources. February 23, 2019 Dr. Mansour Al Batainh

Fixed investment is known as ‘fixed capital formation’, Stock investment is the accumulation of work-in-progress, raw materials and finished goods (this is known as ‘inventory’). Companies will choose to keep excess raw materials in the event of unforeseen contingencies that could disrupt the flow of production. February 23, 2019 Dr. Mansour Al Batainh

11 ‘Material investment’ is the purchase of productive assets (namely plant, machinery, buildings and vehicles) by producers in the economy and is by far the most measured type of investment. largest measure. These producers can be private companies or public sector corporations. An important feature of investments in physical capital is that companies expect to increase profits in the future. The potential gains from investment prompt companies to increase spending on capital goods. February 23, 2019 Dr. Mansour Al Batainh

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Invest in public goods, such as road, rail, satellite or fiber optic cables. Infrastructure investments have some distinctive features as a good investment. First, it usually requires ‘insignificant’ large investments, which take a long time to yield a return. This makes it somewhat unsuitable for private sector investment, which is perceived to have a shorter-term outlook than the public sector and is therefore less willing to make investments that generate only full returns. enough for decades to come. Second, it is public in nature, meaning that private sector companies are likely to underinvest in it because they will not reap the full benefits of that investment. February 23, 2019 Dr. Mansour Al Batainh

Government provides such an important source of investment. However, in the UK, privatizing much of the public sector previously meant the responsibility to invest in critical parts of the economy’s infrastructure. February 23, 2019 Dr. Mansour Al Batainh

Companies are not only interested in increasing fixed assets, but also interested in improving human intangible assets. Human resource development can be considered at least as important as the accumulation of physical capital to improve output and productivity. Increasing education, skills and training has the potential to support economic growth. The impact of human capital on labor quality is measured by the output of each worker. Workers who have accumulated more qualifications through attending school or participating in related training can be expected to be better able to contribute to production than workers. have fewer years of schooling and have no formal training. February 23, 2019 Dr. Mansour Al Batainh

15 Human capital will vary among workers according to family background, education level and skills acquired. Becker claims that in view of this change, workers will have unequal access to high-paying work, which will manifest in an unequal income distribution. Workers will be motivated to invest in education and training to improve their human capital thanks to the prospect of higher pay in high-skill and high-productivity jobs. The higher monetary reward in this case will cause the worker to invest resources to gain qualifications by extending schooling and/or through attending training courses. February 23, 2019 Dr. Mansour Al Batainh

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They will benefit from higher productivity once workers start working. Workers acquire job-specific human capital through ‘on-the-job’ training, acquiring latent skills through work experience on the same or similar tasks. These skills provide an additional source of productivity gains beyond formal education and training. February 23, 2019 Dr. Mansour Al Batainh

17 There can be a trade-off between investment in physical capital and investment in human capital. February 23, 2019 Dr. Mansour Al Batainh

The former can be sold for a post-purchase price, while the latter involves the development of non-tradable knowledge and skills. The decision to buy fixed assets is usually reversible, but the decision to buy “human capital” is irreversible. February 23, 2019 Dr. Mansour Al Batainh

An important point to draw from the above discussion is the CHANGE PROPERTY of workers. In particular, skills will affect the quality and thus productivity of labor. However, there is also a broader issue of labor status and its relationship to investment. Labor is not only concerned with the number of hours worked, as a quantitative measure of the total labor input employed. It also includes aspects of effort and work intensity, in relation to the actual work performed by the worker. Economists usually define labor only in terms of “expansion,” that is, in terms of hours worked as determined by the number of workers employed and the length of time worked. This should be distinguished from the actual contribution of labor to total output/defined in terms of ‘intensive’ by the total effort exerted by the worker. February 23, 2019 Dr. Mansour Al Batainh

Ms 10 Capital Budgeting

20 This raises the question of how hours worked are converted into work effort. This depends on the organization of work and the use of technology. Investment in this case is not simply adding more physical inputs (capital) to the production process through the purchase of additional machines and plants. There is also a problem of getting more out of existing labor input. Employers will look to change the way work is organized and use technology to get more effort from workers. The division of technical labor is a case in point where specialization of job tasks allows companies to gain greater bargaining power over workers. Increased employer control over workers can then be used to increase work speed. Technology that makes it easier for employers to monitor their workforce can be used to achieve the same results. For example, the operation of an assembly line limits worker behavior and reduces their ability to resist increased work intensity. Companies can exploit this situation to get more output from their workforce. One can also envision the positive effects of increased supervisors on work intensity. In cases of close supervision, there is less opportunity for workers to evade labor discipline and as a result they have to increase their work. February 23, 2019 Dr. Mansour Al Batainh

Explain whether the following expenditures should be considered investments and give reasons for your answer. 1 Research and development costs of companies. 2 Government spending on education. 3 Government spending on the NHS. 4 Payments to the employer’s retirement fund. February 23, 2019 Dr. Mansour Al Batainh

How do companies fund their investment plans?