Domestic Investment

Definition

Domestic investment refers to the expenditure on capital goods, such as machinery, equipment, and infrastructure, made within a country's own borders. It is a critical component of the national saving and investment identity, which describes the relationship between national saving, investment, and the current account balance.

5 Must Know Facts For Your Next Test

1. Domestic investment is a key driver of economic growth, as it increases the productive capacity of a country.
2. The level of domestic investment is influenced by factors such as interest rates, tax policies, and the overall business climate.
3. Domestic investment can be financed through national saving, foreign investment, or a combination of the two.
4. Domestic investment is a component of the expenditure approach to measuring GDP, along with consumption, government spending, and net exports.
5. The national saving and investment identity states that the current account balance is equal to the difference between national saving and domestic investment.

Review Questions

• Explain how domestic investment is related to the national saving and investment identity.
  • The national saving and investment identity states that the current account balance is equal to the difference between national saving and domestic investment. This means that if a country's domestic investment exceeds its national saving, the country must be running a current account deficit, which is financed by borrowing from abroad. Conversely, if a country's national saving exceeds its domestic investment, it will be running a current account surplus, which represents net lending to the rest of the world.
• Describe the factors that influence the level of domestic investment in an economy.
  • The level of domestic investment is influenced by a variety of factors, including interest rates, tax policies, the overall business climate, and expectations about future economic conditions. Lower interest rates make borrowing cheaper and can stimulate investment, while higher taxes on investment can discourage it. A stable and favorable business environment, with strong property rights and low regulatory barriers, can also encourage domestic investment. Finally, if businesses and households are optimistic about future economic growth, they are more likely to invest in capital goods and expand their productive capacity.
• Analyze the relationship between domestic investment, GDP, and economic growth.
  • Domestic investment is a key driver of economic growth, as it increases the productive capacity of an economy. When businesses and households invest in capital goods, such as machinery, equipment, and infrastructure, it expands the country's productive potential and allows for greater output of goods and services. This, in turn, leads to an increase in Gross Domestic Product (GDP), which is the total value of all goods and services produced within a country's borders. Over time, this increased productive capacity can translate into higher economic growth rates, as the economy is able to produce more with the same or fewer inputs. Therefore, domestic investment plays a crucial role in fueling sustainable economic growth and development.

Related terms

National Saving: The total amount of savings within a country, including savings by households, businesses, and the government.

Current Account Balance:

The difference between a country's imports and exports of goods, services, and net income from abroad.

Gross Domestic Product (GDP):

The total value of all goods and services produced within a country's borders over a specific period, typically a year.