Principles of economics the investment functionPresentation Transcript
Producers in the economy
must decide how much
income to spend on new
Producers may invest in replacing
used up or obsolete
production, increasing raw
material or finished goods
inventories, and building new
facilities for new products.
Each producer makes
independently of others.
•Investment spending that producers
intend to undertake. These intended
investments do not always end up
The level of national income
doesn’t play the decisive role
in determining investment that
it plays in determining
•Investment that is independent of
the level of income.
EXHIBIT 6 THE INVESTMENT CURVE
How does the investment curve (I)
in Exhibit 6 change as the level of
national income changes?
•The investment curve does not
change. It remains at $75 billion at
every level of national income.
Four factors determine the size of
the economy’s autonomous
1. Technology Level
2. Interest Rate
3. Expectations of Future Economic
4. Rate of Capacity Utilization
•The introduction of new
technologies is one of the
mainsprings of investment.
Technological leaps produce
extensive networks of investment
•Producers undertake investment
when they believe the rate of return
generated by the investment will
exceed the interest rate, that is, the
cost of borrowing investment funds.
•There is an inverse relationship
between the rate of interest and the
quantity of investment spending.
EXHIBIT 7 THE EFFECT OF CHANGES IN THE RATE OF INTEREST ON THE
LEVEL OF INVESTMENT
Why is the demand curve for
investment in panel a of Exhibit 7
•The demand curve for investment is
downward sloping because as the
rate of interest decreases, the level of
investment in the economy increases.
3.Expectations of future
•Investment spending reflects how
producers view the future. Future
expectations are shaped by past
4. Rate of capacity utilization
•Producers seldom choose to operate
at 100 percent capacity. Operating at
less than 100 percent capacity gives
them the ability to expand production
•How much flexibility producers end
up choosing influences the
economy’s level of production. For
producers who choose to operate
close to full capacity, a moderate
increase in sales may shift them
quickly into investment spending.
4. Rate of capacity utilization
The level of investment spending
in the U.S. economy is volatile.
Sometimes the factors that effect
investment spending pull in
opposite directions. Other times,
they work in unison and lead to
impressive economic growth.
EXHIBIT 8 THE VOLATILITY OF INVESTMENT
Unlike consumption, which is fairly stable over time, investment is subject to
erratic fluctuations even through very short periods of time. The economic
and technological factors that influence investment can sometimes create
the conditions for rapid expansion of investment and, just as quickly, reverse
to cause investment to fall just as rapidly, as we see in the annual rate of
change in real investment spending over the years 1960 to 1995.
Source: Economic Report of the President 2006 (Washington, D.C.: United States Government Printing
Office, 2006), p. 285.
How does the rate of investment
spending in Exhibit 8 compare to
the rate of consumption
•While the rate of consumption
spending is fairly stable over time, the
rate of investment spending is volatile.