Net vs Gross Investment
Our revised definition includes “gross investment” along with consumption. What does the word “gross” mean in this context? It indicates, that investment includes all investment goods produced. Gross investment is not adjusted for depreciation, which measures the amount of capital that has been used upin a year. Thus gross investment includes all the machines, factories, and houses built during a year-even though some were produced simply to replace some old capital goods that burned down or were thrown on the scrap heap. If you want to get a measure of the increase in society’s capital, gross investment is not a sensible measure.
Because it excludes a necessary allowance for depreciation, it is too large-too gross. An analogy to population will make clear the importance of considering depreciation. If you want tq measure the increase in the size of the population, you cannot simply count the number of births, for this would clearly exaggerate ‘the net change in population. To get population growth, you must also subtract the number of deaths.
The same point holds for capital. To find the net’ increase in capital, you must start with gross investment and subtract the deaths of capital in the form of depreciation, or the amount of capital used up. Thus to estimate capital formation we measure ‘ net investment. Net investment is always births of capital (gross investment) less deaths of capital (capital depreciation): Net investment equals gross investment minus depreciation.
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