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Why is investment spending more volatile than consumer spending (more prone to large swings)?
December 22nd, 2011 | 
Author: Question by CD: Why is investment spending more volatile than consumer spending (more prone to large swings)?
Best answer:
Answer by Darth Severus
b/c you can postpone getting new equipment for 1-2 years, but you cannot pospone buying necessities such as food, clothing and Halo 3.
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A large part of consumer spending is on necessities such as housing , food , utilities and so on – it is the discretionary segment which is more volatile. Investment expenditure is more a function of how business views economic prospects and the rate of return on capital over a given period of time, market share and other economic conditions and outlooks. These can be quite volatile over the short to medium term, and given that much capital expenditure is ‘discretionary’ rather than ‘necessary’ it is liable to greater fluctuations.
The main reason is that consumption is a fairly constant proportion of GDP or National Income. However, investment is related to the change in GDP or National Income.
To give a simple example, suppose that GDP is growing at a modest rate of 2.5% per year. Investment is needed to expand the capital stock by the same percent so that the nation’s factories can keep up with demand.
Now, however, suppose that the growth rate of the economy increases to 5% per year. Investment in the capital stock has to double so that the capital stock also grows at 5% rather than 2.5%. A modest increase in the rate of growth of the economy can require a large increase in the level of investment. Meanwhile consumption continues to increase but only at a slightly higher rate of 5% instead of 2.5% per year.
Modest changes in the expected rate of growth of the economy can cause huge changes in business plans to invest in new factories or other facilities.
This volatility of investment spending is usually cited as the main cause of fluctuations in the economy, sometimes referred to as the business cycle.