Determinants of Investment

Investment in economics means addition to the stock of physical capital- New Investment/expenditure incurred on addition of capital goods such as machine, plants, building etc. Keynes also includes the increase in inventories of consumer goods in the capital of the country. Autonomous investment by Govt. vs Induced investment private sector induced by profit motive.

Determinants of Inducement to investment

1. MEC: Rate of profit expected from an extra unit of capital. (a) Supply price/ Replacement cost (b) Prospective yield from a capital asset-over its life time. MEC=Net return expected from a new unit of capital

 entrepreneurs will continue to make investment -till E=Interest=MEC Interest> MEC=Reduce Investment Interest < MEC=Increase Investment

 I define the MEC as being equal to that rate of discount which would make the present value of series of annuities given by the returns expected from the capital assets during its life just equal to its supply price Keynes

 Marginal efficiency of capital (expected rate of profit) and replacement cost of capital Interest rate is sticky in the short-run. Therefore I depends on expected profit.

 If aggregate demand cuts AS to the left of full employment line (at point E), it is a state of less than full employment level. If AD cuts to the right of full employment, line (E2), it is the state of equilibrium at over full-employment level.

 Aggregate supply depends on physical and technical conditions of and economy. Higher level of output is possible at rising costs per unit. Consumption does not rise as much as income rises. Consumption demand remain stable in the short run. Investment Demand depends on

 Aggregate demand and aggregate supply will be equal at full employment level only if investment demand is sufficient to cover the gap between the aggregate supply price corresponding to full employment level conclusions & Keynesian economic 1. O & Y depends on employment Employment depends on effective demand. Effective demand comprise of C and investment demand.

 Real Investment = Creates an additional Productive Capacity In Macro-economic analysis, real net investment is taken in to account in both Public Sector and Private Sector. Planned Investment vs Unplanned Investment Unplanned Investment is a forced Investment unintended by the Firm. It takes place when some unsold finished goods accumulate on account of poor sales

 Realised Investment = Planned Investment + Unplanned Investment Induced Investment & Autonomous Investment Induced investment depends upon profit or income expectations. Autonomous Investment is not affected by the level of income or interest or profit motive. It depends on social and political considerations. Marginal Efficiency of Capital (Determinants of Investment)

 According to Keynes, decision to investment in a new project (i.e. private investment) depends upon MEC and the Market Rate of Interest. What is MEC? That rate of discount which equate the total present value of the series of annual incomes expected from the capital asset over its 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

 Essentially, when the stock market is high, 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 investmentdepreciation

Investment Function
Gross investment refers to flow of expenditure on new fixed capital assets such as house machinery, factories, etc. kt = kt-ko kt= Change in the capital stock t=time Net investment= Gross investmentReplacement investment (or capital consumption)

 Financial investment= Does not add to real capital stock. It only leads to transfer of right or ownership from one person to another.

 1. Production related inventories 2. Carrying costs= Interest cost+storage cost Planned inventories Inventories are larger, larger the planned output and smaller the holding cost Unplanned inventory investment or disinvestment takes place when sales and production diverge.

 When sales decline, production is not immediately cut back, inventories accumulate. When sales more up, inventories are drawn down before production responds. The predominant source of financing for inventory holding is bank credit Credit control policies-the main weapon of monetary policy-have their greatest impact on the ability of producers to finance their working capital needs.

 Accelerator principle suggests that rapid growth in income and output stimulates investments. Rate of investments depends on changes in aggregate output, higher investments, in turn, stimulates more output growth, and the process continues until the capacity of the economy is reached, after which the rate of growth slows down. The slower growth, in turn, reduce investment spending and inventory accumulation which tends to send the economy in to a recession.

 Pump priming: Increase private investment through an injection of fresh purchasing power in the form of higher public expenditure Compensatory spending is aimed at compensating the decline in private investment through public works and transfer payments.

 Public debt policy for financing development domestic public borrowing Borrowing from public: less inflationary Borrowing from Banks & Reserve Bank Borrowing from RBI are most inflationary Borrowing form foreign sources ( FDI, FII, IMF, World Bank Concept of Debt Trap and its consequences

Factors Affecting Marginal Efficiency of Capital

Short Term Factors Long Term Factors

 Short Term Factors:

(1)Size of the Market: (2)Future Expectations Concerning Costs and Prices: (3) Propensity of Consume: (4) Psychology of the Entrepreneurs: (5) Level of Income: (6) Taxation Policy:

 Long Term Factors

(1) Population Size: (2) Nature of Economy: (3) Innovations and Consumerism: (4) Globalization and Free Trade: