Economics defines investment as the act of incurring an immediate cost in the
expectation of future rewards. Firms that construct plants and install equipment,
merchants who lay in a stock of goods for sale, and persons who spend time on
vocational education are all investors in this sense. Somewhat less obviously, a firm that
shuts down a loss-making plant is also "investing": the payments IT must make to extract
itself from contractual commITments, including severance payments to labor, are the
initial expendITure, and the prospective reward is the reduction in future losses.
Viewed from this perspective, investment decisions are ubiquITous. Your purchase of
this book was an investment. The reward, we hope, will be an improved understanding of
investment decisions if you are an economist, and an improved abilITy to make such
decisions in the course of your future career if you are a business school student.
Most investment decisions share three important characteristics IT varying degrees.
First, the investment is partially or completely irreversible. In other words, the inITial cost
of investment is at least partially sunk; you cannot recover IT all should you change your
mind. Second, there is uncertainty over the future rewards from the investment. The best
you can do is to assess the probabilITies of the alternative outcomes that can mean greater
or smaller profIT (or loss) for your venture. Third, you have some leeway about the timing
of your investment. You can postpone action to get more information (but never, of
course, complete certainty) about the future.
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