In this paper we have a threefold objective. Firstly, to identify the principal macroeconomic determinants of U.K. private sector investment. Secondly, to examine the effects of private investment on aggregate supply. Finally, we attempt to integrate the effects of public sector investment and pricing on private sector output.

Investigators have modelled private sector or manufacturing investment behaviour in a variety of ways. The neoclassical tradition, associated with Jorgenson (1963), explains investment expenditures in terms of the lagged capital stock, expected output and a distributed lag on the cost of capital. The most recent effort along these lines on U.K. data is the paper by Bean (1981). Although he found significant negative effects of the change in interest rates and the real cost of capital on the change in investment he failed to obtain satisfactory estimates of long-run cost of capital effects on the level of investment. Thus investment was determined solely in relation to output in the steady state. Alternatives to the neoclassical formulation have been proposed in the form of the multiplier-accelerator model and Tobin’s q model, in which changes to the capital stock incur adjustment costs. The former, which have been widely used in macroeconomic models, have generally failed to predict turning points in investment. Oulton (1981) and Dinenis (1984) have had moderate success with q models for the U.K. The major difficulty encountered is that of rationalising the existence of a lag structure for q, the ratio of market value to the current replacement asset cost.