Investment Function

1. Investment Function
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2. Investment
• It is allocating money in the expectation of monetary benefit in the
future.
• Return : It is the benefit from an investment.
• Investments are done in Physical Assets, Financial Assets and Business
Assets.
• Types of investment
1. Induced Investment
2. Autonomous Investment
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3. Induced Investment
• Induced Investment : Influenced by returns or profits like
• Change in Asset prices
• Change in Income
• Low cost of borrowing
• Low wages
• Autonomous Investment:
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4. Autonomous Investments (Ia)
• It is not influenced by income or return expected. Governments do
this for public utility services.
• Irrespective of change (increases or decrease income) in income,
investment is done.
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Income (Y)
Investment I Ia

5. Investment Function
Investments and its determinants are important to know for a
person or company individually. But it is more important for
the governments in the macro economic scenario. Major
factors determining investments
1. Income (Y)
2. Real Interest rate
3. Tobin’s Q
4. Marginal Efficiency of Capital (MEC)
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6. Income
1. Increase in income stimulates investment and fall in income
dampens investment.
2. Regular income is more important than other income sources.
• For a salaried person increase or decrease in salary has more impact
than bonus, ESOP and incentives received.
• For a business man, profit is the regular income when compared to
income from sale of assets, interest received, dividends received
etc.
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7. Types of Income
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Monetary
1. Profits from doing business
2. Dividend received on shares and
mutual funds.
3. Interest received on term deposits,
bonds and debentures.
4. Capital gains on real assets and
financial assets.
5. Wind fall gains like Lottery, Ponzi
schemes, etc…
Manual
1.Salary from dong a job
2.Fee received for rendering professional
services
3.Brokerage or commission received for
intermediation
4. Awards and rewards for competitions,
TV Shows, etc.

8. Real Interest Rate
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9. Marginal Efficiency of Capital (MEC)
1. It is propounded J M Keynes.
2. It is the highest rate of return expected from an additional unit of a capital asset over
its cost.
3. It is the ratio of
i. Rate of return/s or yield/s of capital goods (y).
ii. Cost of capital (k).
4.Future value/s is/are discounted and equated to present value to know the
prospective rate of return.
5.Rate of return is compared with cost of capital (k) or cost of borrowings.
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10. Factors Influencing MEC
1. Capital equipment supply: influences demand supply gap.
2. Change in Income : Rise stimulates and fall dampens investments
3. Expectations: Short term and long term
4. Production methods or techniques: saves costs and improves returns.
5. Propensity to Consume : Increases demand for consumer goods
6. Uncertainty of expected returns
7. Government policy: Promotional measures like subsidies, tax holidays etc.
8. Nature of demand: Short lived, persisting in long run
9. Business cycles : Optimism and pessimism
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11. Tobin’s Q
1. It is the ratio between a physical asset's market value and its replacement value.
2. Initially it was known as Kaldor's V on the name of Nicholas Caldor introduced
this ratio in 1966.
3. James Tobin popularised this ratio and it is also known as Q ratio.
4. It was first introduced by Nicholas Kaldor in 1966 in his article "Marginal
Productivity and the Macro-Economic Theories of Distribution.
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12. MULTIPLIER
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13. Multiplier
• Macro economics uses multiplier to trace the relationship between two
variables and their impact on aggregate demand and income.
• Multiplier measures how much an endogenous variable changes in
response to a change in some exogenous variable.
• Multipliers are used in different contexts
• Money Multiplier : Central bankMoney supply
• Fiscal Multiplier
• Investment multiplier
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14. Money Multiplier (M)
• Banks create money, especially under the reserve ratio system with central bank.
Where money is created whenever a bank gives out a new loan.
• Central bank reserves indicate the size of deposits which further reflect size of
loans in the economy. This continues multiple times, and is called the multiplier
effect (M)
• This makes RBI reserves as an indicator for money supply and its multipier in
India
• For example every increase of one rupee with RBI reserves is seen as increase in
ten rupees of deposits with commercial banks, then the multiplier effect is 10.
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15. Fiscal Multiplier (F)
• This multiplier is used to assess the effects of fiscal policy, or other
exogenous changes in spending, tax rates, subsides, etc on aggregate
output or GDP.
• For example, if Indian government increases its spending for a year by
one rupee which results in GDP increase by Two rupees, then the fiscal
multiplier effect is 2.
• This is how governments do autonomous investments to attain desired
GDP growth rate.
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16. Investment Multiplier (K)
• J M Keynes gave the concept of multiplier in his theory of employment.
It is known as investment multiplier.
• It is the relationship between income and the rate of investment, given the
propensity to consume influencing aggregate employment.
• Multiplier tells us that, when there is an increment of investment, income
will increase by an amount which is K times the increment of investment.
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17. Investment Multiplier
K = ∆Y/∆I
∆Y = K * ∆I
Where
K = Multiplier
∆Y = Change in income
∆I = Change in Investment
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18. Investment Multiplier Derivation
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19. Accelerator
• F A Hayek popularised the accelerator effect.
• It is the positive effect of market or economic growth on private
fixed investments known as acceleration effect.
• The acceleration effect is the phenomenon that a variable moves
toward its desired value faster and faster with respect to time.
• It has reciprocating effect in the economy.
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20. How Accelerator Works?
1. Rising GDP implies growing businesses, increased sales, rising and
profits and greater use of existing capacity (fixed investments).
2. Accelerator implies that profit expectations and business confidence rise,
encouraging businesses to build more factories and other buildings and to
install more machinery through fixed investment.
3. This further leads to the growth of the economy through the stimulation
of consumer incomes and purchases through the multiplier effect.
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21. Thank You
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