What Constitutes the ‘Gross Investment’ of an economy?
That part of our final output that comprises capital goods constitutes gross investment of an economy. These may be machines, tools and implements; buildings, office spaces, storehouses or infrastructure like roads, bridges or airports.
What is Depreciation?
A significant part of current output of capital goods goes in maintaining or replacing part of the existing stock of capital goods. This is because the already existing capital stock suffers wear and tear and needs maintenance and replacement.
A part of the capital goods produced this year goes for replacement of existing capital goods and is not an addition to the stock of capital goods already existing and its value needs to be subtracted from gross investment for arriving at the measure for net investment. This deletion, which is made from the value of gross investment in order to accommodate regular wear and tear of capital, is called depreciation.
Depreciation can also be defined as an annual allowance for wear and tear of capital goods. In other words it is the cost of the good divided by the number of years of its useful life.
To further understand the above definition of Depreciation, Let us consider a new machine that a firm invests in. This machine may be in service for the next twenty years after which it falls into disrepair and needs to be replaced. We can now imagine as if the machine is being gradually used up in each year’s production process and each year one twentieth of its original value is getting depreciated. So, instead of considering a bulk investment for replacement after twenty years, we consider an annual depreciation cost every year.
What is Net Investment?
So new addition to capital stock in an economy is measured by net investment.
| Net Investment = Gross investment – Depreciation. |
What do you mean by Inventory?
In economics, the stock of unsold finished goods, or semi-finished goods, or raw materials which a firm carries from one year to the next is called inventory.
Inventory is a stock variable.
| Change of inventories of a firm during a year ≡ production of the firm during the year – sale of the firm during the year. |
Inventories are treated as capital. Addition to the stock of capital of a firm is known as investment. Therefore, change in the inventory of a firm is treated as investment.