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According to what I have read, investment is the expenditure on creation of capital goods, which means that it is done by producers.

Then why do we treat buying of house by households as investment when they are not doing any production?

In the sense of treating house as investments, we can treat other consumer goods also like investments. For example, if a consumer buys a TV, we could treat that like an investment because he's receiving a benefit for as long as he owns the TV. Why do we treat houses differently?

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  • $\begingroup$ @dismalscience But how is implicit cost related to investment ? $\endgroup$ – Jonathann Nov 21 '18 at 2:40
  • $\begingroup$ @dismalscience That robot would be an investment , right ? $\endgroup$ – Jonathann Nov 21 '18 at 8:44
  • $\begingroup$ @dismalscience We are taking the housing services which are our implicit cost like rent ? $\endgroup$ – Jonathann Nov 21 '18 at 8:51
  • $\begingroup$ @dismalscience Is there any other example other than purchasing house by households which can be termed as investment by households ? $\endgroup$ – Jonathann Nov 21 '18 at 9:20
  • $\begingroup$ The existing answers didn't seem to have answered your question, which seems to be about why housing is treated differently from other capital goods, so I've added what I hope is a clear explanation. $\endgroup$ – dismalscience Nov 23 '18 at 15:38
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Definitions:

  • Investment is the purchase of any (new) capital goods.
  • A capital good is any good that is used to produce other goods and services.

A house produces a stream of housing services. Hence, a house may be regarded as a capital good. And thus, the purchase of a house may be regarded as investment.


Note though that definitions and lines in economics can often be fuzzy and there can be grey areas. You are quite right to question whether we should count the purchase of a house as investment. One could argue that we shouldn't. However, by convention in national income accounting, we do, with the above as our rationale.

As noted in the UN System of National Accounts (2008, p. 8):

No matter how simple and precise concepts and classifications may appear in principle, there are inevitably difficult borderline cases which cannot easily be fitted into predetermined categories. ...

The general nature and purpose of the distinction between gross fixed capital formation and consumption, whether intermediate or final, is clear. The distinction is fundamental for economic analysis and policymaking. Nevertheless, the borderline between consumption and gross fixed capital formation is not always easy to determine in practice. Certain activities contain some elements that appear to be consumption and at the same time others that appear to be capital formation. In order to try to ensure that the SNA is implemented in a uniform way, decisions have to be taken about the ways in which certain difficult, even controversial, items are to be classified.


In response to an incorrect comment that claims that "The purchase of a new house is not counted as investment":

BEA glossary:

Consists of purchases of private residential structures and residential equipment that is owned by landlords and rented to tenants.

Blanchard, Macroeconomics (2017, p. A-3):

Residential investment (...) is the purchase of new houses or apartments by persons.

Mankiw, Macroeconomics (2015, p. 27):

Residential investment is the purchase of new housing by households and landlords.

Hubbard & O'Brien, Macroeconomics (2017, p. 255):

Residential investment is spending by households and firms on new single-family and multi-unit houses.

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  • $\begingroup$ What is stream of housing services ? Any example ? $\endgroup$ – Jonathann Nov 21 '18 at 8:40
  • $\begingroup$ @Jonathann: When a homeowner lives in her home, she enjoys housing services that she might otherwise have to pay for (e.g. by renting an apartment elsewhere). We refer to such "living" (over the course of months and years) as a "stream of housing services". $\endgroup$ – Kenny LJ Nov 21 '18 at 8:51
  • $\begingroup$ Is there any other example other than purchasing house by households which can be termed as investment by households ? $\endgroup$ – Jonathann Nov 21 '18 at 9:19
  • $\begingroup$ @Jonathann: I can't be sure but I don't think so. I believe housing is unique in this regard -- all purchases by households fall under $C$ (Consumption) with the sole exception of new housing, which falls under $I$ (Investment). $\endgroup$ – Kenny LJ Nov 21 '18 at 9:24
  • $\begingroup$ In the sense of treating house as investment , we can treat other consumer goods also like investment. Eg. If someone buys pen , then implicit cost of using pen is he may write some article that would fetch him marks or maybe if consumer buys T.v the implicit cost is he the amount he would have earned if he would have charged other for watching tv $\endgroup$ – Jonathann Nov 21 '18 at 10:14
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The main categories and subcategories are

  • Capital goods categorized further in productive capital goods and utility-enhnacing capital goods
  • Consumpitin goods, categorized further into durable goods and perishable goods. Roughly,perishable consumption goods is what we eat and drink and whet we use one. Durable goods are all the rest: a TV, a private car, are considered as durable goods.

These are useful concepts but they do not produce a razor-sharp criterion to characterize goods. And they are not consistent with each other either: we subcategorize capital goods per their intended use, while we subcategorize consumption goods per their life span. So a car bought by a company for its sales force is considered as productive capital good, while a car bought by an individual for its own private use is considered a durable consumption good.

To stick to the OP's question, what is a residential house? Is it a "utility-enhancing capital good" or a "durable consumption good"? Traditionally, we classify it in the former category, mainly because of the magnitude of its value and implied long life span, compared to "usual" durable consumption goods.

Now the concept of investment (in economics, not in everyday usage of the word), is closely if not exclusively linked to production, so "investment" by households in buying residential housing appears to not qualify... and it doesn't: in many empirical studies of investment, purchases of residential houses are clearly distinguished from investments done by businesses.

In parsimonious and highly abstract macroeconomic models, the distinction tends to be made much less often.

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TL;DR: From the point of view of the national accounts, when someone buys a house, they're not doing it as a member of a household, they're doing it as (and this is a direct quote as highlighted below), "unincorporated enterprises that produce housing services that are consumed by the household to which the owner belongs."

After earlier proposing to close, I now see from other answers and comments that this area is broadly misunderstood, and you thus obviously have a good question here.

From your question, I can see that you understand the conceptual distinction between enterprises, which definitionally invest and produce, and do not consume (as all their purchases are considered to be intermediate inputs to production), and households, which definitionally consume and do not invest or produce.

In this view, it's easy to see why you'd wonder why we carve out the purchases of residential structures and treat them differently.

The answer is that we don't actually treat them differently from the view of the national accounts, because we've created an accounting fiction that treats a person who owns their own home both as an enterprise and as a household. This has been encoded from the start; it appears even in the first System of National Accounts, the international framework for national accounting.

Importantly, it is not, as one of the other answers states, just a convention, just because homes create housing services. If that were the case, we'd also treat other consumer durables, like cars and appliances as investments, but we don't, as you correctly point out in your comments.

Rather, it's done for a very specific reason, which is that if we didn't create this accounting fiction, then comparisons between countries or over time could be distorted by differences in the homeownership rate.

Consistent Comparisons

Let's imagine that we stuck with the straightforward approach, which would be to treat all purchases by households as consumption, and treated houses just like we treat cars.

If we did this, then GDP in Japan, for example, would be artificially higher than GDP in the US, because the US has a higher homeownership rate, and conversely, more households in Japan are renters— and rent payments definitely belong in GDP. So just because the same thing (a house) was owned differently in different countries, GDP would differ. We wouldn't want that.

Worse yet, consider a house that was built before the financial crisis and sold (and thus counted in GDP as consumption). Now imagine that the homeowner was unable to make their mortgage payments, and the house was foreclosed on and sold to an investor, who rented it out. The house, already counted in GDP at its initial sale, would then be counted in GDP as a rental, artificially inflating GDP in the aftermath of a financial crisis. We wouldn't want that, either.

The Accounting Fiction

The solution to this, as I mentioned before, has been explicitly accounted for in the System of National Accounts since its first version in 1953. This SNA makes clear the distinction you make between enterprises and households, saying

In other words the production boundary is drawn by first separating households from enterprises and then separating two types of purchases by enterprises, namely those which are and those which are not charged to current cost.

The SNA then goes into the case of primary producers (i.e., farms, etc.), which are in many ways similar, as they're households, but they produce something (food, rental services), which may be consumed by them or by others (if they sell some of what they grow or take in a tenant on an informal basis). The SNA then proposes that farm households be treated both as households and as enterprises:

For instance, farm households are not only households from the consuming point of view but also enterprises which engage in agricultural production.

It goes on to draw a parallel with homeownership:

The farming imputation [note: counting farm production for own use in GDP] made for such economies accords with the rules given for primary producers and the rental imputation [note: counting in GDP what homeowners would be paying in rent if they were renting] accords with the rules given for other producers if account is taken of the face that home-ownership is a regarded as a trade.

This is then encoded in the definition of enterprises:

ENTERPRISES include all firms, organizations and institutions which produce goods and services for sale at a price intended approximately to cover the cost of production. The class of enterprise includes the following categories: [...] (b) All households and private non-profit institutions in their capacity as landlords of dwellings whether or not they occupy their own properties.

In short, we divide households that own their own homes into two entities: the household as such, and the person who bought the house as a landlord. This is made even more clear in the most recent version (2008):

Persons who own the dwellings in which they live are treated as owning unincorporated enterprises that produce housing services that are consumed by the household to which the owner belongs. The housing services produced are deemed to be equal in value to the rentals that would be paid on the market for accommodation of the same size, quality and type. [...] The imputed values of the housing services are recorded as final consumption expenditures of the owners.

Emphasis mine.

How this affects investment

So now we understand that people who purchase homes are being treated as enterprises, rather than households, and then renting the house to the household to which they belong.

From here, the relationship should be straightforward. Because homeowners are enterprises, it's not inconsistent to treat the purchase of the asset as an investment, it's perfectly appropriate.

Further, it should be obvious that doing it any other way would complicate comparisons between countries and over time, the same way that not imputing rent would. If we counted homes that were purchased as consumption, we'd be measuring much lower investment in countries just because they had higher homeownership rates. Similarly, in cities, it's not at all uncommon for apartment buildings that were constructed with rentals in mind to be sold as condos, or vice versa, depending on changes in funding and local market conditions. You wouldn't want measured investment to rise or fall because of this.

Further implications

There are two quick further implications that are worth touching on:

(1) The full purchase price of a home is not to be counted as investment, only the structure is. Per the BEA:

In the NIPAs, private investment in new construction is measured mainly as the sum of the costs of inputs of all construction “put in place,” that is, all construction activity completed in a given period.

Obviously, this means in part that the land that the house is build on is not counted in GDP, either as investment or construction, as it's just a transfer.

More importantly, though, it's also supposed to exclude consumer durables unless the home is rented— because a refrigerator shouldn't count as an investment when it comes with a home but not when you're replacing it later on.

(2) It's possible to imagine other items, like cars, being treated like houses in the future. If the companies that are trying to build fleets of driverless cars manage to take a larger bite out of private car ownership, we'll have the same issue with cars that we do with homes, where measured GDP and investment over time would be significantly affected by the share of cars that were owned vs. rented (this is already something of an issue due to motor vehicle leasing). We'd see more recorded investment because the cars were owned by enterprises, and we'd see lower volatility in GDP, because every convert to driverless cars would be someone not being recorded as making an all-at-once consumption purchase, instead showing up as a consumer of a stream of services over time.

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