Determinants of Investment

7/31/2019 Determinants of Investment

1/22

Determinants of Investment

Investment in economics means addition tothe stock of physical capital- NewInvestment/expenditure incurred on additionof capital goods such as machine, plants,building etc.

Keynes also includes the increase ininventories of consumer goods in the capitalof the country.

Autonomous investment by Govt. vs Inducedinvestment private sector induced by profitmotive.


2/22

Determinants of Inducement toinvestment

1. MEC: Rate of profit expected from anextra unit of capital.

(a) Supply price/ Replacement cost

(b) Prospective yield from a capitalasset-over its life time.

MEC=Net return expected from a newunit of capital


3/22

entrepreneurs will continue to makeinvestment -till

E=Interest=MEC

Interest> MEC=Reduce Investment

Interest < MEC=Increase Investment


4/22

I define the MEC as being equal to thatrate of discount which would make thepresent value of series of annuities

given by the returns expected from thecapital assets during its life just equalto its supply price Keynes


5/22

Marginal efficiency of capital (expectedrate of profit) and replacement cost ofcapital

Interest rate is sticky in the short-run.Therefore I depends on expected profit.


6/22

If aggregate demand cuts AS to the leftof full employment line (at point E), it isa state of less than full employment

level. If AD cuts to the right of fullemployment, line (E2), it is the state ofequilibrium at over full-employment

level.


7/22

Aggregate supply depends on physicaland technical conditions of andeconomy.

Higher level of output is possible atrising costs per unit.

Consumption does not rise as much as

income rises. Consumption demandremain stable in the short run.

Investment Demand depends on


8/22

Aggregate demand and aggregatesupply will be equal at full employment

level only if investment demand issufficient to cover the gap between theaggregate supply price corresponding

to full employment level conclusions &Keynesian economic

1. O & Y depends on employment

Employment depends on effectivedemand. Effective demand comprise ofC and investment demand.


9/22

Real Investment = Creates an additionalProductive Capacity

In Macro-economic analysis, real netinvestment is taken in to account inboth Public Sector and Private Sector.

Planned Investment vs UnplannedInvestment

Unplanned Investment is a forced

Investment unintended by the Firm. Ittakes place when some unsold finishedgoods accumulate on account of poorsales


10/22

Realised Investment = PlannedInvestment + Unplanned Investment

Induced Investment & AutonomousInvestment

Induced investment depends uponprofit or income expectations.

Autonomous Investment is notaffected by the level of income orinterest or profit motive. It depends on

social and political considerations. Marginal Efficiency of Capital

(Determinants of Investment)


11/22

According to Keynes, decision to investmentin a new project (i.e. private investment)

depends upon MEC and the Market Rate ofInterest.

What is MEC?

That rate of discount which equate the totalpresent value of the series of annualincomes expected from the capital asset overits life time and the supply price of the asset

is called MEC. With the increase in the level of investment,

the MEC of capital falls and vice-versa


12/22

Essentially, when the stock market ishigh, most firms find it profitable to

expend. Gross investment= Total expenditure

on purchase or construction of new

capital goods. Capital stock depreciates or wears out,

which reduces the capital stock

Net investment= Gross investment-depreciation


13/22

Investment Function

Gross investment refers to flow ofexpenditure on new fixed capital assets suchas house machinery, factories, etc.

kt = kt-ko kt= Change in the capital stock t=time

Net investment= Gross investment-

Replacement investment (or capitalconsumption)


14/22

Financial investment= Does not add toreal capital stock. It only leads totransfer of right or ownership from one

person to another.


15/22

1. Production related inventories

2. Carrying costs= Interest cost+storagecost

Planned inventories

Inventories are larger, larger the plannedoutput and smaller the holding cost

Unplanned inventory investment ordisinvestment takes place when sales andproduction diverge.


16/22

When sales decline, production is notimmediately cut back, inventoriesaccumulate. When sales more up,inventories are drawn down beforeproduction responds.

The predominant source of financing forinventory holding is bank credit

Credit control policies-the main weapon ofmonetary policy-have their greatest impacton the ability of producers to finance theirworking capital needs.


17/22

Accelerator principle suggests that rapidgrowth in income and output stimulatesinvestments. Rate of investments dependson changes in aggregate output, higherinvestments, in turn, stimulates more outputgrowth, and the process continues until thecapacity of the economy is reached, afterwhich the rate of growth slows down. The

slower growth, in turn, reduce investmentspending and inventory accumulation whichtends to send the economy in to a recession.


18/22

Pump priming: Increase private

investment through an injection offresh purchasing power in the form ofhigher public expenditure

Compensatory spending is aimed atcompensating the decline in privateinvestment through public works and

transfer payments.


19/22

Public debt policy for financingdevelopment

domestic public borrowing Borrowing from public: less inflationary

Borrowing from Banks & Reserve Bank

Borrowing from RBI are mostinflationary

Borrowing form foreign sources ( FDI,

FII, IMF, World Bank

Concept of Debt Trap and itsconsequences


20/22

Factors Affecting MarginalEfficiency of Capital

Short Term Factors

Long Term Factors


21/22

Short Term Factors:(1)Size of the Market:

(2)Future Expectations Concerning Costsand Prices:

(3) Propensity of Consume:

(4) Psychology of the Entrepreneurs:

(5) Level of Income:

(6) Taxation Policy:


22/22

Long Term Factors(1) Population Size:

(2) Nature of Economy:(3) Innovations and Consumerism:

(4) Globalization and Free Trade:

Documents

Determinants of Investment