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Investment

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  • 1. Investment
  • 2. • Investment refers to that part of the aggregate output which takes the form of construction of new structure. It should be noted, that if a person purchases bonds, shares or debentures, generally people said that he has made an investment, but it should not be considered as an investment. In true sense it is not real investment; real investment is the investment which determines the national income and the employment level of the country. Buying of shares or bonds, or debentures is only a financial investment; it cannot increase the employment or the national income of the country. So we can say that, real investment is the addition of the stock of physical capital, like machines, tools, equipment and the buildings.
  • 3. • Investment can be either gross or net, from the gross investment; the replacement investment must be deducted in order to obtain the net investment in the economy. Investment also has a positive relationship with the level of employment, in other words if there is an increase in the investment level the employment level will also increases. According to Prof. Dudley,” A fundamental principle is that as the income of a community increases, consumption is also increases but less than the increase in income. Hence, in order to have sufficient demand to sustain an increase in employment, there must be increase in real investment equal to the gap between income and consumption out of income. In other words, employment cannot increase, unless investment increases1.” It is clear from the above discussion that the investment has a positive impact on the level of employment
  • 4. Autonomous Investment and Induced Investment• Investment can be further divided into two parts, the first one is autonomous investment and the second one is induced investment. Autonomous investment is that investment which does not vary with the change in income, or there is no relationship between investment level and income level. According to Prof. Keynes, the amount of investment depends on the marginal efficiency of capital (MEC), and rate of interest. According to him, income level will not affect the level of investment. He has further suggested that the level of income can affect the amount of investment only in the long-run, but in short-run, level of income can not affect the level of investment. Only the marginal efficiency of capital (MEC) and the rate of interest can affect the level of investment in the short-run. In fact the distinction between autonomous and induced investment has been made by the post-Keynesian economists.
  • 5. Autonomous Investment• In general sense, only the government does the autonomous investment for the purpose of economic growth and development. It should be noted that the investment done by the government is not for making the profit or income, like the investment in the roads, bridges, hospitals and other infrastructure developmental projects.• According to Prof. Hicks,” Public investment means investment which occurs in direct response to invention and much of the long – run investment which is only expected to pay for itself over a long period, all of these can be regarded as autonomous investments.”
  • 6. • This type of investment largely depends on the growth of population, technological progress, and developmental activities of the government, rather than the level of income. The motive behind the autonomous investment is not to earn profit but for the development of the economy. Like, in public sector units, the aim of government is not to earn profit but to fulfill the needs of the people. As we have discussed it earlier these investment are independent of change in income and are not governed by profit motive. These types of investments are generally made by the government and the local authorities for social welfare rather than to make profit.
  • 7. • In the same fashion government does a huge investment in the railway and on road transportation. You can imagine that for 35 Kilometer’s government is taking only Rs. 5, but in case of private transport you have to pay many times of it. In a nutshell we can say that, autonomous investment refers to the investment which does not depend upon changes in the income level. These are investment expenditures that would occur even if national income was zero.We can understand the concept of autonomous investment with the help of a figure that is given below,
  • 8. • In the above figure, we have assumed the national income on X axis, and level of investment on the Y axis. The level of autonomous investment has been shown by the line Ia, Ia, which is parallel to X axis, it shows that it does not vary with the change in income, or there is no relationship between investment level and income level. As we can see in the above figure, whatever be the level of national income, the level of autonomous investment is same, as we have discussed it earlier that the level of autonomous investment depends on the technological advancement and also on the growth of population, instead of growth in national income.
  • 9. Induced Investment• On the other hand, induced investment changes with the changes in the level of income, or in other words we can say that, induced investment is that investment which is affected by the changes in the income. As we know that if the level of income is high, people will consume more or the level of consumption increases, and to produce more consumer goods, larger investment is needed in capital goods. According to Prof. Keynes, it is the rate of interest which can affect the level of induced investment. In other words we can say, if the level of income increases, people will start to consume more, to meet the additional consumption, the level of production of consumer goods has to be increase that is only possible after the investment in capital goods.
  • 10. • The induced investment is undertaken both in fixed capital assets and in inventories. ”The essence of induced investment is that greater income and therefore greater aggregate demand affects the level of investment in the economy. The induced investment underlines the concept of the principle of accelerator, which is highly useful in explaining the occurrence of trade cycles.1” The concept of induced investment can also be understand with the help of a figure, that is given below,
  • 11. • In the above figure (2), we have assumed the national income on X axis and the level of investment on Y axis, the level of induced investment has been shown by the line, Ii Ii, it is clear from the figure that the level of induced investment is increasing with the increment in the level of national income, or in other words we can say that there is a direct relationship between level of national income and the level of induced investment. As we have discussed it earlier that if the level of income increases, people will start to consume more, to meet the additional consumption, and the level of production of consumer goods has to be increase that is only possible after the investment in capital goods. According to Prof. Keynes, the rate of interest can also be affects the level of induced investment.
  • 12. Investment multiplier• The number of times total income increases, corresponding to an increase in the investment is known as investment multiplier Or it can be rewritten as For example if Y (national Y) rises by ` 2000 as a result of an increase in investment of `1000 then the k coefficient is 2 (2000/1000).
  • 13. • The concept of multiplier was first developed by Prof. F. A. Kahn in the early 1930s. The concept of multiplier has a vital role to play in the theory of employment and income. After some time Prof. Keynes has refined the concept of multiplier. It should be noted that there is a difference between the multiplier developed by Prof. Kahn and the multiplier developed by Prof. J. M. Keynes, Prof. Kahn has developed the employment multiplier and further Prof. Keynes has refined it and developed the investment multiplier.
  • 14. • ΔC = c(ΔY) ……….1• (The above equation (1) shows, the change in consumption equals to the marginal propensity to consume multiplied by the change in income.)• ΔY = kΔI…………….2• (The above equaltion (2) shows the change in income equals the investment multiplier multiplied the change in investment)• ΔY = ΔC + ΔI………..3• (Equation (3) shows the change in income also equals to the change in consumption plus the change in investment)• Now we can say that,• → kΔI = c(kΔI) + ΔI………4
  • 15. • (Therefore arrording to the equation (4), the investment multiplier multiplied by the change in investment equals the marginal propensity to consume multiplied by the investment multiplier multiplied by the change in investment)• → kΔI – c(kΔI) = ΔI• or• → kΔI(1-c) = ΔI• after the cancilation of ΔI from, ΔI, we get,• → 1-c = 1/k• or, we can rewrite it as,• → c = 1-1/k
  • 16. • The working of multiplier can be understand with the help of an example which is given below, as we have already discussed that the number of times total income increases, corresponding to an increase in the investment is known as investment multiplier. Suppose the government undertakes the investment expenditure of ` 500 crores, than the income will not rise by ` 500 crores only, but it can increase many times more. It depends on the marginal propensity to consume (MPC) of the people.
  • 17. • Suppose in first step the income of the people will increase by only ` 500 crores. Let’s assume that the MPC of the people is 80 percent, as we know that the Marginal Propensity to Consume has to play a crucial role in the determination of multiplier and it is also a very important concept because it tells us how much part of the increased income is consumed and how much saved. Marginal propensity to consume is the ratio of change in consumption to the change in income.• In the above case people will spent `400 crores out of `500 crores, or in other words 80 percent of the `500 crores. This `, further increases the income of the people by `, 400, because the people will spent their income on the consumer goods, and further this increment of income ` 400 will increase the consumption by 80 percent of ` 400 crores. And the process will continues, the result was many times increment in the income than the investment done initially.•
  • 18. Thanks

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