Investment vs. consumption 1 | Finance & Capital Markets | Khan Academy (2023)


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The difference between investment and consumption. Created by Sal Khan.

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Finance and capital markets on Khan Academy: When are you using capital to create more things (investment) vs. for consumption (we all need to consume a bit to be happy). When you do invest, how do you compare risk to return? Can capital include human abilities? This tutorial hodge-podge covers it all.

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I've been wanting to make a video on a couple of terms that people have really thrown around for a while now.

And I think it really hits the core of some of the issues we're dealing with now with the credit debacle, but it's kind of at a deeper level.


The things I want to go over are the ideas of savings, consumption, and investment.


You hear these a lot.

Everyone, obviously says, I've invested in the stock market or I've invested in a house and I really want to give you a framework for how I think about these ideas.

And, frankly, I haven't seen them depicted this way in any economics book, although they've kind of touched on this, but I think this is really how you should think about these things.


If you save money, and I, think we all know what that means.

That's money that you didn't spend, there's a couple of things that you can do with it.

You can either consume your money or you could invest your money.


Let's just think about a bunch of different situations and think about whether those things are consumption or investment.


Let's say, I have $100,000 that I'm dealing, with.

So, let's say, I, take that $100,000 and I build a factory.

And I think that that factory is going to be able to produce-- I'll, make up some product-- it'll be able to produce cars more efficiently and cheaper than any other car factory out.


Well, I think we'd all agree that this is an investment.


Why is it an investment?, Because I'm, taking this $100,000 and I'm, putting it to some use that is creating, hopefully, more value than my original $100,000.

In fact, I'm, expecting some type of a return on this investment.

And I've made a bunch of videos on what a return on investment is, and you can usually quantify it.

If I.

Take a $100,000 and I build this factory, and this factory spits out $50,000 a year, it's probably creating at least $50,000 a year value, assuming that nothing corrupt is happening in our system.

In fact, it's normally creating more than $50,000 a year of value.

It may be creating a $100,000 a year of value and $50,000 of that may be going to the person who's doing the production and then the other half of the value is actually going to the consumer of whatever this factory is making.


You have to think about it, because if all of the value went to the person who produced the factory, then there's not a huge incentive for someone to use his products.


But anyway,! That's not the topic of discussion.


Just trying to get at a mental framework on what consumption is versus, investment., So I think we all agree that if I were to build a factory that this is-- let's say, I'll do everything in green as investment.

So building a factory is an investment.


Let's say that I'm, homeless and I have this $100,000.

And, because I'm homeless, I don't have a place to go and eat dinner and rest and relax.

Because I don't have that, I can't get a job, and I can't become a productive member of society.

So maybe, I'm, going to use this $100,000 to buy a simple house that meets all of my needs.

Let's say: build a simple house, and I'll do that in a neutral color.

This is my other use of this $100,000.

Instead of building a factory, I'm going to build a simple house.

And, this house, it provides shelter for me and my family.

It allows us that security that now my kids can go to school and they can themselves become more productive.


I now have an address.

I have a place to take a shower, that allows me to go.

Get a job and I can now create value for society as a whole, instead of being on the corner and begging for money from people.

I would argue that this is also an investment.

Why is it? Because I'm, taking this $100,000, that maybe I had or someone gave to me, and it's generating a return.


What is that return? Well, with a factory,? It's maybe a little easier to quantify.

But at minimum.

It's this work that I'm able to do because I now have a house.

Because I have the security, I? Have the address.

I? Have the shelter.

I'm able to relax.

It's that security? And it's also the return that probably my kids are going to be able to now contribute to society.


If they grew up homeless, they would have never been able to contribute.

And now that they have a roof over their head, and are able to go to school, et cetera.

They are going to be able to give some economic value back to society.

It's hard to value.

Maybe I didn't have any job before and now.

I have a job and I can contribute $30,000 a year to society.

Maybe I'm working at someone's factory.

Maybe I'm, providing some other-- maybe I'm, a farmer now.

Whatever, I'm, providing some source of value.

And, maybe my kids--.

If they never got an education, they would have maybe added $10,000 of value per year to people and now they can add $20,000 of value.


That difference would also be some of the return on this investment.

So I also consider this to be an investment.


My question to you: is.

Let's say that I already had a house-- so this is an investment.

Let's, say I already had a house and my family is happy and we have everything we need.

We have food on the table and my kids go to school and I'm able to get a job and all of that exists.

But, let's say, I still have a $100,000 and I use that $100,000-- I'll.

Do it in yellow-- to put in some granite counter.


I have some money left over, let's say, I'm, going to add a bathroom to my house and I will put the latest hardwood floors, so that my family will be impressed.

You can imagine.

And, maybe I, add 2,000 square feet.

You normally can't get all that for a $100,000, but I think you'll bear with me.

So I'm, essentially doing some major home improvements.


My question to you: is--.

Is this an investment, or is this consumption? Now, in our everyday world,? With most people we deal with,? They will call this investment in my house.


Why are they saying that? Because they say, by spending a $100,000 in the house in this way, that maybe-- if you watch the Home and Garden channel, they're doing this all the time-- that if you pour this a $100,000 into your house, that maybe the value of your house is going to increase by $150,000.

Or someone else, all of a sudden, is going to perceive the value of your house as being $150,000.

They'll say, well, you got a $50,000 return on investment.

I'd argue that that is not investment.


It's speculation., You are, essentially, piling money into this stuff-- and I'll.

Do this in red, consumption is red.

What's happening here; truly economically? When, you add granite, or you add an extra bathroom or hardwood floors or this extra 2,000 square feet.

Is it making anyone who's living in that house more productive? Is it making you harder working;? Is it making you more likely to invent the cure for cancer, or more likely to invent a way of getting cheap, energy, or produce more widgets? No,? It's just,! If anything, providing more things for you to have to take care, of, that you're not going to be able to focus as much on your work.

Or, more energy is going to have to be extended to maintain this type of place, to heat and cool, a 2,000 square foot house.

So, if anything, by actually pouring the $100,000 here, you're, actually creating something that is going to suck more out of society.

In fact.

In no way is this going to contribute to the collective wealth of society.


Last two examples: I gave contribute to the collective wealth society, some of which you share, and that is your return on the investment.

But as a whole.

This is an investment into society.


It's going to make the pie bigger.

This right, here, does not make the pie bigger.

It might make you a little bit happier, make your ego feel a little bit better.

Let your pride grow, and your self righteousness grow, and show other people that you've arrived, but it's not going to increase the wealth of society.

And when you say that you've invested, you are really just saying: I've, speculated., What, you're, saying is--.

By paying this $100,000, you're going to find, essentially, a greater fool out, there.

They could have done the same thing.

They could have bought your house, spent $100,000 and done this.

If this is what would have made them, happy.

But, what you're saying is, essentially, that you're going to find somebody out there who's willing to pay $150,000 extra for something that should have only cost $100,000.

And in fact.

If anything.

If you use this at all, the value of this is going to go.


So you're, just somehow, assuming that the granite counter tops that you choose are going to be the taste that someone else would like or that the hardwood floors are going to be the taste someone else would like.

I would actually argue that when you customize your house in this way, you are creating $100,000 of consumption to your taste.

And I'd be surprised if someone else, truly, is willing to pay more than $100,000 unless they're being, in some way, irrational or they can finance this, because it's part of the mortgage.

Anyway, this is, I think, just the big picture: investment adds value to society.

A simple house adds value to society.

Consumption is something where people might call it an investment, because it's kind of speculation.

One might find some other guy willing to emotionally pay more for something.


It's money, that's burned;! It's not creating more value for society.

I continue this in the next video.


What is the difference between consumption and investment? ›

Consumption is the purchase of goods and services for the acquisition of current utility. Investment is expenditure on capital goods for the acquisition of future utility.

Is buying a new house an investment or consumption? ›

Answer and Explanation: Macroeconomics classifies buying a house as part of investment. Consumption involves all the commodities and services used within a household.

What is an investment in AP macro? ›

In macroeconomics, investment "consists of the additions to the nation's capital stock of buildings, equipment, software, and inventories during a year" or, alternatively, investment spending — "spending on productive physical capital such as machinery and construction of buildings, and on changes to inventories — as ...

What is the difference between consumption assets and investment assets? ›

Note that investment assets do not have to be held exclusively for investment. (Silver, for example, has a number of industrial uses.) However, they do have to satisfy the requirement that they are held by some traders solely for investment. A consumption asset is an asset that is held primarily for consumption.

What is the theory of consumption and investment? ›

Consumption And Investment Theory

Investment and consumption are interrelated. Investments are the sum of any income received minus the amount consumed. Keynes' theory of consumption, commonly known as “absolute income theory,” emphasizes the absolute size of income as a factor in determining consumption.

What are 4 types of investments? ›

There are four main investment types, or asset classes, that you can choose from, each with distinct characteristics, risks and benefits.
  • Growth investments. ...
  • Shares. ...
  • Property. ...
  • Defensive investments. ...
  • Cash. ...
  • Fixed interest.

Is buying a car an investment or consumption? ›

And the fact is that a car represents a significant financial outlay on an asset that will depreciate between 10% and 20% in the first year after leaving the dealership. In other words, looking at it strictly as an investment, you are allocating your money to something that will be worth less money year after year.

Why a house is not considered an investment? ›

A house has a more important primary purpose

Probably the single biggest reason why a house is not an investment is that its primary purpose is providing you with a place to live. So, it's not something you can really do without — like a company stock or a share of a mutual fund, for example.

Why is residential construction considered an investment rather than consumption? ›

Explanation: Expenditures on new housing is categorized as an investment rather than consumption. This is because the purchase of the home will be used for many years and will likely appraise in value.

Is macro an easy AP? ›

AP Macroeconomics is considered quite easy, with class alumnae rating it 4.6/10 for overall difficulty (the 19th-most-difficult out of the 28 large AP classes surveyed). The pass rate is lower than other AP classes, with 51% graduating with a 3 or higher.

Is AP Micro Macroeconomics hard? ›

As mentioned previously, AP Microeconomics course material was designed to mimic an introductory college-level course, so it will certainly be more difficult than a standard high school class.

Is AP Macroeconomics worth taking? ›

Taking AP Macroeconomics helps you understand the economic principles and outcomes that shape the world's economy. Additionally, you learn essential skills like problem-solving and using graphs and data to analyze economic concepts.

What are 3 types of investment assets? ›

Historically, the three main asset classes have been equities (stocks), fixed income (bonds), and cash equivalent or money market instruments. Currently, most investment professionals include real estate, commodities, futures, other financial derivatives, and even cryptocurrencies in the asset class mix.

What are the similarities between consumption and investment? ›

Investment and consumption both decrease your fund. Both are the application of your saved cash. Both provide you happiness and satisfaction. Without both, you can not survive in the society.

Why does investment vary more than consumption? ›

The reason why investment varies from time to time is that, unlike consumption, investment does not depend on income level. This means that for consumption to vary, the individual's level of income must either increase or decrease, thus shifting.

What are the 3 investment theories? ›

The theories are: 1. The Accelerator Theory of Investment 2. The Internal Funds Theory of Investment 3. The Neoclassical Theory of Investment.

What are the three theories of consumption? ›

It also describes the main mainstream theories of consumption, which are the life cycle income hypothesis, the permanent income hypothesis and the random walk theory of consumption.

What are the three important theories of consumption? ›

The three most important theories of consumption are as follows: 1. Relative Income Theory of Consumption 2. Life Cycle Theory of Consumption 3. Permanent Income Theory of Consumption.

What are the 4 C's of investing? ›

Real Estate Investment Strategist and…

When it comes to obtaining funding for a real estate property purchase, private lenders will typically consider four key factors: credit, cash flow, collateral, and capacity. These factors are often referred to as the "4 C's" of lending.

What are the 7 types of investment? ›

Read on to know what's right for you.
  • Stocks. Stocks represent ownership or shares in a company. ...
  • Bonds. A bond is an investment where you lend money to a company, government, and other types of organization. ...
  • Mutual Funds. ...
  • Property. ...
  • Money Market Funds. ...
  • Retirement Plans. ...
  • VUL insurance plans.

What are the 5 classes of investment? ›

Generally, investments fall into five broad asset classes:
  • Cash and cash equivalents.
  • Fixed-income securities.
  • Stocks and equities.
  • Investment funds.
  • Alternative investments.
Dec 12, 2022

Why are cars not considered an investment? ›

Key Takeaways. A car is a depreciating asset that loses value over time but can retain some worth. Vehicles immediately begin losing value once the owner takes possession.

Is consumption a stock concept? ›

Income, expenditure, production, consumption, and interest are the major examples of flow variables.

Is your car a capital asset? ›

Capital assets are significant pieces of property such as homes, cars, investment properties, stocks, bonds, and even collectibles or art. For businesses, a capital asset is an asset with a useful life longer than a year that is not intended for sale in the regular course of the business's operation.

Why owning a house should not be your biggest investment? ›

Exceptions exist, but in most cases, you won't earn a great return by owning a home, if you properly account for the opportunity cost, the lifestyle inflation, the hidden expenses, the loss in flexibility, and the value of your time. In most cases, it is actually a very poor financial investment.

Is rent consumption or investment? ›

Personal consumption consists of all resources used to fulfill individual needs and wants, and rent lies under the personal consumption components.

What is not counted as investment? ›

In calculating GDP, investment does not refer to the purchase of stocks and bonds or the trading of financial assets. It refers to the purchase of new capital goods, that is, new commercial real estate (such as buildings, factories, and stores) and equipment, residential housing construction, and inventories.

Is home construction part of investment or consumption? ›

Construction of new homes is part of the investment component of GDP.

What is a disadvantage of investing in residential real estate? ›

Real estate investments tend to have high transactional costs, especially in legal and brokerage fees. The process of acquiring a new property is also very long and tedious with lots of legal formalities. Another disadvantage of property investments is that they are not easy to liquidate.

What is the largest component of spending in the United States? ›

Consumer spending comprises 70% of GDP. The retail and service industries are critical components of the U.S. economy.

What is the hardest AP class? ›

Physics 1

This class combines physics, scientific inquiry, and algebra. AP Physics 1 is considered one of the hardest AP classes, covering topics like Newtonian mechanics and electrical charge and force. Students also spend about 25% of their class time performing college-level lab experiments and writing reports.

What's the easiest AP class? ›

Easiest AP exams by pass rate
  • AP Art & Design: Drawing.
  • AP Art & Design: 2-D.
  • AP Calculus BC.
  • AP Chinese Language.
  • AP English Literature.
  • AP French Language.
  • AP Government & Politics.
  • AP Italian Language.
Jan 13, 2023

How many is too many AP classes? ›

Take as many as you can handle without spreading yourself thin, and make sure you will have time to study for the ACT or SAT this year. An Ivy League hopeful might take 3 to 5 AP classes, while if you're aiming for less-selective schools, 2 to 4 would be enough.

What is the hardest AP Micro unit? ›

“AP Microeconomics students' strongest unit was Unit 3, Production, Cost, and the Perfect Competition Model. 20% of students answered virtually every question about this unit correctly.” “AP Microeconomics students' most imperfect unit was, fittingly, Unit 4, Imperfect Competition.

Can I self-study AP Microeconomics? ›

Microeconomics is just the economics of everyday life rather than economics on a grand scale, which is why it is micro and not macro. The College Board is aware of the fact that most students are doing self-study in order to pass the exam.

Is it hard to get a 5 on AP Micro? ›

Based on the 2022 AP score distributions, only 17.7% of students received a 5. Alternatively, you would need to have earned 83.3% of the total available composite points on the AP Micro exam to score a 5.

Does AP Macro require calculus? ›

There are no prerequisites for AP Macroeconomics. Students should be able to read a college-level textbook and possess basic mathematics and graphing skills.

Do AP classes really matter that much? ›

Students looking to earn admission to highly selective colleges should take multiple AP classes to bolster their applications and demonstrate they can handle challenging coursework. Some college admissions experts recommend taking as many as 7-12 AP courses before applying to the most elite universities.

What are the 5 major assets in financial market? ›

They are arranged as per the reaction to each asset's market fluctuations, nature, and financial goals. There are five crucial asset categories: derivatives, fixed income, real estate, cash & cash equivalents, and equity. Also, the alternative categories include bitcoins and hedge funds.

Are houses an asset? ›

Given the financial definitions of asset and liability, a home still falls into the asset category. Therefore, it's always important to think of your home and your mortgage as two separate entities (an asset and a liability, respectively).

Is consumption or investment more important? ›

Impact of consumption and investment

Consumption increases current utility and leads to higher living standards in the short-term. Investment will require less current consumption but can enable higher living standards in the long term. This shows a trade off for an economy between consumer goods and capital goods.

Is buying a house considered an investment or consumption? ›

Answer and Explanation: Macroeconomics classifies buying a house as part of investment. Consumption involves all the commodities and services used within a household.

Is government spending consumption or investment? ›

Government consumption expenditures include spending by governments to produce and provide services to the public, such as national defense and education.

What are the two basic determinants of investment spending? ›

The basic determinants of investment are the expected rate of net profit that businesses hope to realize from investment spending and the real rate of interest. When the real interest rate rises, investment decreases; and when the real interest rate drops, investment increases--other things equal in both cases.

What happens to consumption and investment when interest rates fall? ›

Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices.

Is buying military equipment consumption or investment? ›

For each form of government spending, indicate whether it represents consumption or investment. Government consumption spending includes paying workers to administer government programs; government investment spending includes buying military equipment, building roads, and building bridges.

What is the difference between savings investment and consumption? ›

Saving involves forgoing some present consumption. Money which is saved constitutes withdrawal from the circular flow of income. However, part of savings may come back into income flow through investments. Sense of responsibility.

What is considered an investment vehicle? ›

An investment vehicle is a product used by investors to gain positive returns. Investment vehicles can be low risk, such as certificates of deposit (CDs) or bonds, or they can carry a greater degree of risk, such as stocks, options, and futures.

Why is buying a car not an investment? ›

Cars are depreciating assets, meaning they lose value over time. New cars are the worst. That's because the biggest depreciation comes in the first year, with a big chunk of that coming when you drive it away, and it goes from new to used.

What are the four main determinants of investment? ›

What are the four main determinants of​ investment? Expectations of future​ profitability, interest​ rates, taxes and cash flow. How would an increase in interest rates affect​ investment? Real investment spending declines.

How much cash should I have on hand vs investing? ›

A general rule of thumb for how much of your investment portfolio should be cash or cash equivalents range from 2% to 10%, although this very much depends on your individual circumstances.

Why is saving safer than investing? ›

The biggest difference between saving and investing is the level of risk taken. Saving typically results in you earning a lower return but with virtually no risk. In contrast, investing allows you the opportunity to earn a higher return, but you take on the risk of loss in order to do so.

Is it better to save in cash or bank? ›

It's a good idea to keep a small sum of cash at home in case of an emergency. However, the bulk of your savings is better off in a savings account because of the deposit protections and interest-earning opportunities that financial institutions offer.

What are the primary determinants of consumption and investment? ›

The key determinants of consumption include income, savings, expectations, changes in fiscal policy, debt levels, and the availability of goods and services.

Are stocks and bonds consumption or investment? ›

By investment, economists mean the production of goods that will be used to produce other goods. This definition differs from the popular usage, wherein decisions to purchase stocks (see stock market) or bonds are thought of as investment. Investment is usually the result of forgoing consumption.

Why is consumption less volatile than investment? ›

Answer and Explanation: The investment spending is more volatile as compared to the compared spending. This is because the investment level varies from one year to another financial year. Any change in interest rate greatly affects the investment spending in the economy.

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