Gross investment and depreciation

Investment has both a short-run and a long-run role. Lower investment immediately reduces a component of aggregate demand and may reduce income through the multiplier. Over time it also slows capital formation, lowers productive capacity, and limits future output and employment. Macroeconomics studies these economy-wide effects.

The safest procedure is to calculate net investment first: net investment = gross investment − depreciation. Then interpret its sign. A positive result means capital stock increases, zero means depreciation is exactly replaced, and a negative result means capital stock falls. Looking only at gross investment can mistake replacement spending for expansion, so A is the reliable method.

Depreciation is broader than physical wear. Capital may lose productive usefulness because it becomes technologically obsolete, even if it still physically exists. With zero net investment, there is no net addition to offset such loss in capacity. Consumption, export earnings, and population growth do not describe this capital-value loss.

An increase in finished-goods inventories is included in investment because it represents current production that has not yet been sold. It is recorded as change in stocks or inventories, a component of gross capital formation. An old house is an existing asset, shares are financial transactions, and pensions are transfer payments; none represents current investment production.

Land is a pre-existing natural asset, so merely transferring ownership of it does not create current output. The purchase price may be recorded as an asset transaction, but not as expenditure on current production. In contrast, constructing a new factory building is a current productive activity that creates a fixed asset. It is therefore included in gross fixed capital formation under the expenditure method.

Retained earnings are profits generated by an enterprise but kept within the business instead of being distributed to shareholders. They remain part of the return to ownership and entrepreneurship. In the income method, this type of enterprise income is included in operating surplus, along with relevant profits, rent, and interest components. It is not employee compensation or a transfer payment.

GDP is called a gross measure because it includes production before deducting consumption of fixed capital, commonly called depreciation. If depreciation is ignored, the measure does not reveal how much of the capital stock has been used up or worn out during production. Net Domestic Product is obtained by subtracting depreciation from GDP. Hence option A identifies the main drawback correctly.

Routine repair generally maintains an existing asset and may be treated as an intermediate expense when it is used by a producer during current production. A newly purchased machine is a newly produced capital good that increases or replaces productive capacity and is recorded as gross investment or capital formation. Thus, their economic treatment differs.

The value of output includes sales plus the change in inventory. Inventory change = closing stock − opening stock = 405 − 310 = 95 lakh rupees. Thus, value of output = 1,950 + 95 = 2,045 lakh rupees. Net value added is value of output − intermediate consumption − depreciation = 2,045 − 760 − 125 = 1,160 lakh rupees. Therefore, B is correct.

Inventory change is closing stock minus opening stock: 370 − 460 = −90 lakh rupees. Therefore, value of output = sales + inventory change = 2,700 − 90 = 2,610 lakh rupees. Applying the net value-added concept, subtract intermediate consumption and depreciation: 2,610 − 990 − 150 = 1,470 lakh rupees. Hence, option A is correct; the stock decline must not be added as a positive amount.