Fixed Capital Investment
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Fixed investment in
economics Economics () is a behavioral science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and interac ...
is the purchase of newly produced physical asset, or,
fixed capital In accounting, fixed capital is any kind of real, physical asset that is used repeatedly in the production of a product. In economics, fixed capital is a type of capital good that as a real, physical asset is used as a means of production which i ...
. It is measured as a flow variable – that is, as an amount per unit of time. Thus, fixed investment is the sum of physical assets such as machinery, land, buildings, installations, vehicles, or technology. Normally, a company balance sheet will state both the amount of expenditure on fixed assets during the quarter or year, and the total value of the stock of fixed assets owned. Fixed investment contrasts with investments in labour, ongoing operating expenses, materials or financial assets. Financial assets may also be held for a fixed term (for example, bonds) but they are not usually called "fixed investment" because they do not involve the purchase of physical fixed assets. The more usual term for such financial investments is "fixed-term investments". Bank deposits committed for a fixed term such as one or two years in a savings account are similarly called "fixed-term deposits". Statistical measures of fixed investment, such as provided by the
Bureau of Economic Analysis The Bureau of Economic Analysis (BEA) of the United States Department of Commerce is a U.S. government agency that provides official macroeconomic and industry statistics, most notably reports about the gross domestic product (GDP) of the United ...
in the United States,
Eurostat Eurostat ("European Statistical Office"; also DG ESTAT) is a department of the European Commission ( Directorate-General), located in the Kirchberg quarter of Luxembourg City, Luxembourg. Eurostat's main responsibilities are to provide statist ...
in Europe, and other national and international statistical offices (e.g., the
International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution funded by 191 member countries, with headquarters in Washington, D.C. It is regarded as the global lender of las ...
), are often considered by economists to be important indicators of longer-term economic growth (the growth of output and employment) and potential
productivity Productivity is the efficiency of production of goods or services expressed by some measure. Measurements of productivity are often expressed as a ratio of an aggregate output to a single input or an aggregate input used in a production proce ...
. The more fixed capital is used per worker, the more productive the worker can be, other things being equal. For example, a worker who tills the soil only with a spade is normally less productive than a worker who uses a tractor-driven plough to do the same work, because with a tractor one can plough more land in less time, and thus produce more in less time, even if a tractor costs more than a spade. Obviously one would not normally use a tractor to plough a small garden, but in large-scale farming the income earned using a tractor by far outweighs the expense of using a tractor. It is not economical to use a spade for large-scale ploughing, unless the labour is extremely cheap, and the supply of labour is plentiful. The level of fixed investment by businesses also indicates something about the level of confidence that business owners or managers have about the ability to earn more income from sales in the next few years. The reasoning is that they would be unlikely to tie up additional capital in fixed assets for several years or more, unless they thought it would be a commercially viable proposition in the longer term. If there is too much uncertainty about whether their fixed investment will pay off, they are unlikely to engage in it. In recent decades, the growth rate of fixed investment in the US, Europe and Japan was relatively low, but in China for example it is relatively high. Often the relativities are expressed as a ratio between
gross fixed capital formation Gross fixed capital formation (GFCF) is a component of the expenditure on gross domestic product (GDP) that indicates how much of the new value added in an economy is invested rather than consumed. It measures the value of acquisitions of new or ...
and
GDP Gross domestic product (GDP) is a monetary measure of the total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performance o ...
, or fixed investment per worker employed or
per capita ''Per capita'' is a Latin phrase literally meaning "by heads" or "for each head", and idiomatically used to mean "per person". Social statistics The term is used in a wide variety of social science, social sciences and statistical research conte ...
.


Why fixed?

The use of the term "fixed" does necessarily not mean the asset "stays in one place", i.e., it does not mean that it is physically ''immobile'', but it refers rather to the circulation (rotation) of flows of capital. Normally, for the purpose of
accounting Accounting, also known as accountancy, is the process of recording and processing information about economic entity, economic entities, such as businesses and corporations. Accounting measures the results of an organization's economic activit ...
, fixed investment refers to "physical assets held for one year or more". The investment capital is therefore "fixed", in the precise sense that the capital is tied up in physical assets for a longer time, and thus cannot be used for other purposes. This contrasts with, for example, investment capital in the form of liquid bank deposits earning interest, or investment in raw materials completely used up in (say) five weeks to produce products which, upon sale, earn income the following month. The term "fixed investment" may be somewhat ambiguous, because it could refer to the value of a ''stock'' of fixed assets being held at a balance date, or as in economics, to the value of a ''flow of expenditures'' on fixed assets across an accounting interval, such as a year. The distinction is not always clearly stated in statistical tabulations—they might refer either to the stock of capital tied up in fixed assets at a balance date, or to how much was spent on fixed equipment during a quarter or year.


Measurement

The amount of fixed investment may be stated "gross" (before taking into account depreciation) or "net" (after depreciation). By subtracting disposals of fixed assets from additions to fixed assets in an accounting period, we obtain a measure of the net (fixed) capital formation. In official statistics, attempts are often made to estimate the value of
fixed capital In accounting, fixed capital is any kind of real, physical asset that is used repeatedly in the production of a product. In economics, fixed capital is a type of capital good that as a real, physical asset is used as a means of production which i ...
assets in a nation, the value of their
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, an actual reduction in the fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation i ...
(or
consumption of fixed capital Consumption of fixed capital (CFC) is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets. CFC is used in preference to "depreciation" to emphasize that fixed capital is used up in the process ...
) and the value of
gross fixed capital formation Gross fixed capital formation (GFCF) is a component of the expenditure on gross domestic product (GDP) that indicates how much of the new value added in an economy is invested rather than consumed. It measures the value of acquisitions of new or ...
by sector and type of asset. Fixed assets
depreciate In accountancy, depreciation refers to two aspects of the same concept: first, an actual reduction in the fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation i ...
over time, due to wear and tear and market obsolescence. At the end of their useful lifetime (perhaps 7–10 years), they possess only a scrap-value (or at the very least must undergo maintenance work or repairs). The concept of "gross fixed capital formation" (GFCF) used in official statistics however does not refer to ''total fixed investment'' in a country. *Firstly GFCF measures only the value of ''additions'' to the fixed capital stock ''less'' the value of disposals of scrapped fixed assets. So normally total fixed investment in a year is in fact a larger value than GFCF. "Total fixed investment" (gross) is not usually a published statistical measure, since economists are interested primarily in the contribution of fixed investment to
value added Value added is a term in economics for calculating the difference between market value of a product or service, and the sum value of its constituents. It is relatively expressed by the supply-demand curve for specific units of sale. Value added ...
, i.e., they are interested in the net additions made to the total fixed capital stock (additions less withdrawals). If, hypothetically, the amount of fixed investment and the amount of scrapped fixed assets are equal in value, then the total fixed investment figure would tell us only that the scrapped fixed assets have been replaced. If we want to know by how much the fixed capital stock has increased, we need to know the relationship between fixed assets purchased and disposals of fixed assets. *Secondly, GFCF does not include land purchases, only investments in
land improvement Land development is the alteration of landscape in any number of ways, such as: * Changing landforms from a natural or semi-natural state for a purpose such as agriculture or housing * Subdividing real estate into lots, typically for the purpo ...
, mainly because land purchased by one person or company from another does not normally increase the total amount of land there is (except in cases of
land reclamation Land reclamation, often known as reclamation, and also known as land fill (not to be confused with a waste landfill), is the process of creating new Terrestrial ecoregion, land from oceans, list of seas, seas, Stream bed, riverbeds or lake ...
such as
polders A polder () is a low-lying tract of land that forms an artificial hydrological entity, enclosed by embankments known as dikes. The three types of polder are: # Land reclaimed from a body of water, such as a lake or the seabed # Flood plains ...
). All that happens is that the same land changes owners. If land is sold, it may yield a
capital gain Capital gain is an economic concept defined as the profit earned on the sale of an asset which has increased in value over the holding period. An asset may include tangible property, a car, a business, or intangible property such as shares. ...
for the seller, but such profits from land sales are not usually made explicit in official statistics, in part because a standard valuation of what the land was previously worth is often difficult to operationalize, in particular if the land was improved or developed by the seller. The value of land can increase or decline due to all kinds of factors, and land valuations may differ from place to place. At best one could estimate the total value of land sales in an accounting interval. For statistical purposes, investment in fixed capital must be distinguished from investment in
intermediate goods Intermediate goods, producer goods or semi-finished products are goods, such as partly finished goods, used as inputs in the production of other goods including final goods. A firm may make and then use intermediate goods, or make and then sell, o ...
. Unlike fixed assets, intermediate goods (for example, commodities like oil, electricity, timber, steel and grain) are completely used up in production (usually within a year). But this distinction is not always easy to draw, for example: *if raw materials are held for more than one year before they are used, *if expenditure occurs to install, service, insure or repair fixed assets (which can be part of the purchase contract) *if physical "fixed" assets are sold off again in less than one year. In official statistics, various accounting conventions are adopted to deal with these problems in a standardized way. A further complication is that scrapped fixed assets, being second-hand goods, may be resold and re-used again (for example, second-hand vehicles).


Theories of fixed investment determination

One theory of the determination of fixed investment focuses on the discrepancy between the current quantity of the fixed capital stock and the optimal or target capital stock. The target capital stock—the level at which a firm's profits would be highest if actual fixed capital holdings equaled that level—is determined as the level at which the
marginal product of capital In economics, the marginal product of capital (MPK) is the additional production that a firm experiences when it adds an extra unit of input. It is a feature of the production function, alongside the labour input. Definition The marginal product ...
equals the
marginal cost of capital In economics, the marginal cost is the change in the total cost that arises when the quantity produced is increased, i.e. the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it ...
. Then the flow of net investment per unit of time is determined by balancing losses from having a less-than-optimal level of capital with the adjustment costs of installing new capital; these adjustment costs in per-unit terms may be an increasing function of the speed of installation. Another theory of fixed investment determination is based on
Tobin's q Tobin's q (or the q ratio, and Kaldor's v), is the ratio between a Asset, physical asset's market value and its replacement value. It was first introduced by Nicholas Kaldor in 1966 in his paper: ''Marginal Productivity and the Macro-Economic Theo ...
, the ratio of the market value to the acquisition cost of an additional unit of physical capital; investment is hypothesized to be an increasing function of this ratio.


Trends

Fixed investments nowadays can be enormous (for example, a nuclear power plant might be built for three billion dollars). This creates more risk and means that many financial guarantees and insurance arrangements become necessary.


See also

*
Capex Capital expenditure or capital expense (abbreviated capex, CAPEX, or CapEx) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered ...
*
Capital accumulation Capital accumulation is the dynamic that motivates the pursuit of profit, involving the investment of money or any financial asset with the goal of increasing the initial monetary value of said asset as a financial return whether in the form ...
*
Capital formation Capital formation is a concept used in macroeconomics, national accounts and financial economics. Occasionally it is also used in corporate accounts. It can be defined in three ways: *It is a specific statistical concept, also known as net invest ...
*
Consumption of fixed capital Consumption of fixed capital (CFC) is a term used in business accounts, tax assessments and national accounts for depreciation of fixed assets. CFC is used in preference to "depreciation" to emphasize that fixed capital is used up in the process ...
*
Depreciation In accountancy, depreciation refers to two aspects of the same concept: first, an actual reduction in the fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation i ...
*
Economics terminology that differs from common usage In any technical subject, words commonly used in everyday life acquire very specific technical meanings, and confusion can arise when someone is uncertain of the intended meaning of a word. This article explains the differences in meaning between ...
*
Fixed capital In accounting, fixed capital is any kind of real, physical asset that is used repeatedly in the production of a product. In economics, fixed capital is a type of capital good that as a real, physical asset is used as a means of production which i ...
*
Gross fixed capital formation Gross fixed capital formation (GFCF) is a component of the expenditure on gross domestic product (GDP) that indicates how much of the new value added in an economy is invested rather than consumed. It measures the value of acquisitions of new or ...
*
Inventory investment Inventory investment (also private inventory) is a component of gross domestic product (GDP). What is produced in a certain country is naturally also sold eventually, but some of the goods produced in a given year may be sold in a later year rather ...
* Opex *
Opportunity cost In microeconomic theory, the opportunity cost of a choice is the value of the best alternative forgone where, given limited resources, a choice needs to be made between several mutually exclusive alternatives. Assuming the best choice is made, ...
*
Sunk cost In economics and business decision-making, a sunk cost (also known as retrospective cost) is a cost that has already been incurred and cannot be recovered. Sunk costs are contrasted with '' prospective costs'', which are future costs that may be a ...


References

{{Reflist


External links

*System of National Accounts 200

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