INVESTMENT

Investment refers to expenditure which increases the value of capital goods such as machines, factories houses etc. Investment expenditure includes expenditure for producer’s durable equipment, new construction and the change in inventories. There are two types of investment:

1)      Induced Investment – It is investment expenditures that are based on level of income and profits. It means induced investment increases with increase in income or profits and decreases with decrease in income or profits.

2)      Autonomous Investment – It is investment expenditures that are not based on level of income and profits earned by economy. It means autonomous investment is not affected by level of income and profits. This investment is made to increase the level of aggregate demand in economy.


Determinants of Investment

1)      Marginal Efficiency of Capital – It is expected rate of return of an additional unit of capital goods over its cost.

2)      Rate of Interest – Rate of interest refers to cost of amount invested. If  investor takes a loan to invest, then he has to pay interest to concerned party. But if he has his own amount and he purchases government bonds with it. In that case, he will receive interest. But if he invest his amount in his business, then he will not receive any interest.


INVESTMENT MULTIPLIER

Concept of multiplier is an important concept of Keynes’ theory of income, output and employment. This concept relates to change in income as a result of change of investment. It is an economic fact that when investment increases there is also an increase in income. But increase in income is many times more than the increased investment. The number of times it increases is called multiplier. Keynesian concept of multiplier establishes a relationship between investment and income.
Multiplier (K) = Change in Investment / Change in Income
                     K = ∆y/∆I   
  
Relation between Multiplier (K)  and Marginal Propensity to Consume (MPC)

The value of multiplier is in fact determined by the Marginal Propensity to Consume (MPC). Higher the MPC, greater is the size of multiplier. On the contrary, lower the MPC, smaller is the size of multiplier. It is so because from the point of view of the entire economy, expenditure of one individual is the income of another. When the investment is increased, income of the people also increased. They spend a part of this increased income on consumption and rest they save.  The amount of income to be spent on consumption depends on their MPC. If MPC is more, they will spend large portion of their income on consumption. As a result of this expenditure on consumption, income of some other people will increase. Thus, increase in investment does not cause increase in income in the same proportion rather income increases many times more than initial increase in investment. The value of multiplier depends on MPC. Higher the MPC, greater the value of multiplier and hence greater the increase in income. Thus, there is a direct relation between multiplier and MPC.




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