There are essentially 2 methods to calculate GDP of a country. Both methods ultimately tries to measure the total value of goods and services produced in the country during a particular period.
2/n
A simple thread to understand the meaning of investment cycle (Gross Fixed Capital Formation) in the economy and why it is important?
Which sectors can benefit in such cycle and why?
Do share if you find it useful.
1/n
There are essentially 2 methods to calculate GDP of a country. Both methods ultimately tries to measure the total value of goods and services produced in the country during a particular period.
2/n
2. Expenditure method of GDP calculation takes into account all purchases of goods and services in the country.
3/n
consumer spending(C), government spending (G),
business investment spending (I), and net exports (x-m)
Formula:
GDP = C + I + G + (X − M) is the formula for EXPENDITURE method of GDP.
4/n
This is known as "Gross Fixed Capital Formation"
5/n
6/n
A rise in GFCF contributes towards higher aggregate demand and most importantly also increases productive capacity of the economy.
7/n
The construction of this manufacturing plant will lead to expenditure of cement, steel, machinery, etc.
This is the 1st level of demand creation by such investment which helps the GDP grow.
8/n
This way, investment in manufacturing plant led to rise in demand and also increased productivity at the same time.
9/n
An investment in a manufacturing plant will be more impactful than constructing a residential building. While both are important, the multiplier impact is higher of the former.
10/n
If more resources are spent on capital goods, it leads to a decline in consumption of consumer goods.
11/n
If instead of spending on investment, the company gave cash bonuses to its employees or dividends to shareholders, it may lead to some immediate spurt in consumption of goods.
12/n
But when it does, in the long run, it also creates supply thereby doesn't push inflation up.
Distributing cash instead of investing, may lead to demand pull inflation.
13/n
It creates quality and more sustainable growth environment in the economy.
14/n
Countries with higher rate of growth are heavily investing in more fixed assets formation to enable rapid economic growth. China has one of the highest rates of gross fixed capital formation.
15/n
On the other hand, developed countries like UK and US are more geared towards consumption spending. All they want is inflation come back. 🙂
16/n
However, it has remained muted in last couple of years due to multiple issues.
17/n
Investments improved till 2013 but then took a back seat. This lead to fall in aggregate growth trend in last couple of years.
18/n
It will create demand and employment both, with control on inflation.
19/n
With real-estate cycle turning, even household my spend more on buying properties and thereby aid household GFCF cycle.
20/n
