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


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. So the things I want to go over
are the ideas of savings, consumption, and investment. And 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. So 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. So, let’s just think about a
bunch of different situations and think about whether those
things are consumption or investment. So 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 there. Well, I think we’d all agree
that this is an investment. And 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. And 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 anymore. But anyway, that’s not the
topic of discussion. We’re 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. Now 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 citizens. 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. And 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. Maybe 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. So that difference would also be
some of the return on this investment. So I also consider this
to be an investment. Now, 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 tops. 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. So 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. And 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. That 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. The 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. And 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 down. 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. But it’s money that’s burned;
it’s not creating more value for society. I continue this in
the next video.

Paul Whisler

20 Comments

  1. Very egalitarian ideas that you resolve on. Yes, the bubble was constructed on social ideas of egalitarianism but ended with America's brokers once again searching for unlimited wealth. Promising a dream of homeownership is evil, but falsifying profits on a proven bad security concept from the original savings and loan bailout is simply criminal.

  2. Lol, your wife must not like this video. I'm most certain in the back of her mind she would like that kitchen with the granite counter tops and the wooden floors.

  3. I'm definitely happy renting right now vs owning a home mortgage. But I would imagine that you could get some damn good deals out of this mess if you have the money on hand to buy a house. Financing is obviously not going to happen too easily.

  4. i dont agree with u sal when u said that spending $100000 on items like granite counter tops etc will not make any collective contribution to society. Think about a person who who deals in granite business dont u think his business will flourish when you are spending money on these features of the house. that business will do flourish and he may be able to contribute positively towards society when lets say.. he pay bonuses to employees working in the granite sector.

  5. my wife is gonna kill me…..i spent all of the sunday attached to your financial video's…..
    it is sooo addictive…….thanks

  6. First off as others have said buying granite and such likethat creates further jobs a direct benefit to the community. Investing on your house isn't as direct as 100 k and 150 k out . It's very tricky. Too much investement and you won't get return if the land in your area is too cheap. However if your 100k house is on a street with 300k homes your better off doing the upgrade, to help everones on your streets wealth

  7. what you dont invest, you consume and vice versa. countries with a high savings9investment) tend to be technological better off and hence have a higher output per worker and higher standard of living. yhowever the united states gdp is mostly made up of consumption, about 70% if not higher. if anything a consumption tax seems like a viable solution to decrease consumptions and hence increase investment which would lead to more growth.

  8. @djsuperstar717 freakan geat question. i would argue that it is an investment because the future of waste will be e-waste (and on a side note you are helping save trees) . The E-waste industry will invest in new plants. no longer which will create new electronics products from your old electronics. but it comes down to how efficient they can be in executing their plans

  9. @djsuperstar717
    If you read only for entertainment it's Consumption.
    If you read only to educate yourself it's an Investment.
    Probably it will be both, it's up you you what the ratio is.

  10. In capitalism investment doesn't exist without concumption. I would argue that consumption is productive to society by allowing the granite factory worker to be paid, the company that makes the hardwood floor to be profitable, ect. The only problem is that it has to be an ever growing system finding new products to sell. We end consuming conspicuously consuming. However the economy demands consumption to exist. Easy profits in useless products. Captialism

  11. Playing Devil's Advocate for a moment, one might argue that the extra money that you can make by installing the new bathroom, etc. is a result of your willingness to put up with the construction (noise, work) and of your artistic vision.

    There is the risk that the future buyers won't enjoy the fruits of your labor as much as you'd hoped, but that doesn't mean that your speculation isn't an investment; you just misjudged the market.

  12. The problem with thinking of these things as investments is the time between when you build your improvement and when you are able to sell it. If you bought the house in order to sell it, that would be one thing. But to "invest" in something that you're going to hold onto for another 10 years will give you very low rates of return. The additional risk makes it an even poorer choice.

  13. This is obviously a concept that has been simplified for ease of understanding, as well as to send a message, however the message sent seems counterintuitive to the rest of the video. A better example of raw consumption would have been gambling, or to take the $100,000 and buy an expensive car, or on a smaller scale buy into the technology upgrade cycle. Upgrading your house may or may not be frivolous, but it isn't prudent to make a blanket statement that says it is, and should be avoided.

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