►GROSS FIXED CAPITAL FORMATION

Relevance: Prelims: Economy

What is Gross Fixed Capital formation?

  • It is essentially net investment.
  • It is a component of the Expenditure method of calculating GDP.

WHAT IT INCLUDES?

  • Land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment purchases; the construction of roads, railways, private residential dwellings, and commercial and industrial buildings.
  • Disposal of fixed assets is taken away from the total.

WHAT IT EXCLUDES?

  • Land Purchases
  • Effects of depreciation (referred to as consumption of capital)

MACROECONOMIC IMPACT

  • In macro theory, a rise in investment should contribute towards higher aggregate demand and also increase productive capacity.
  • Increasing investment should lead to higher economic growth in the long-term though it depends on how effective the investment is.
  • Opportunity cost of investment: The opportunity cost of gross fixed capital investment is lower consumption – at least in the short-term. If more resources are spent on capital goods, it leads to decline in consumption of consumer goods.

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