Investment
Hey Mumbai University SYBA IDOL students! Today, we’re diving into the fascinating world of Macro Economics , exploring the chapter – “Investment“. Here’s what we are going to cover:
First, we’ll explore what investment is and understand its importance in the economy. We’ll explain the types of investment with the help of diagrams, showing the differences between fixed investment, inventory investment, and residential investment.
Next, we’ll explain the concept of the Investment Multiplier. We’ll see how an initial increase in investment can lead to a larger increase in total income and output in the economy.
Finally, we’ll explain the calculation and leakages of the investment multiplier. We’ll understand how to calculate the multiplier effect and discuss factors that can reduce its impact, such as savings, taxes, and imports.
So, SYBA IDOL Mumbai University students, get ready to unwrap the mysteries of “Investment” with customized IDOL notes just for you. Let’s jump into this exploration together.
Question 1:- What is Investment? Explain the types of investment with the help of diagram
Introduction:-
Investment is a key concept in macroeconomics that plays a significant role in determining national income, employment, and capital formation in a country. It involves the addition to the stock of capital or the creation of new capital assets such as plants, machinery, transportation vehicles, and new factories. These assets help generate income and employment in the economy. Real investment involves the creation of physical capital that directly impacts economic growth and development.
Types of Investment:-
- Autonomous Investment Autonomous investment is independent of changes in income levels. It is not influenced by the current level of income but is based on factors like population growth and technical progress. Examples of autonomous investment include the construction of roads, buildings, and other infrastructure projects. Autonomous investment is represented by a horizontal curve in a diagram, indicating that it remains constant regardless of changes in income levels.
- Induced Investment Induced investment is directly influenced by changes in the level of income. As income levels rise, consumption increases, leading to higher demand for goods and services. This increased demand prompts businesses to invest more to meet the growing consumer needs, resulting in an increase in investment levels. Induced investment is depicted by an upward-sloping curve in a diagram, showing the positive relationship between income and investment.
Diagram:-
Diagram Explanation:-
The diagram below illustrates autonomous and induced investment. In this diagram:-
- The X-axis represents national income.
- The Y-axis represents investment.
- The autonomous investment curve (IAIA’) is depicted as a horizontal line parallel to the X-axis, indicating that autonomous investment remains constant regardless of changes in national income.
- The induced investment curve (II) shows a positive slope, reflecting the relationship between income and investment where higher income levels lead to increased investment.
Conclusion:-
Understanding the distinction between autonomous and induced investment is crucial in macroeconomics. Autonomous investment remains constant and is influenced by factors other than income, such as population growth and technical progress. Induced investment, on the other hand, is directly related to changes in income levels. As income increases, so does induced investment, leading to higher economic activity and growth. This distinction helps economists and policymakers make informed decisions to promote economic stability and growth. By recognizing these types of investments and their impacts on the economy, one can better understand the dynamics of economic growth and development. This knowledge is essential for making policies that foster sustainable economic progress.Question 2 :- Explain the concept of Investment multiplier
Introduction:
The investment multiplier is a pivotal concept in economics that elucidates how a change in initial investment can lead to a magnified impact on the overall economy. It showcases the interconnectedness of economic activities and the ripple effect of investment on income and employment levels. Understanding the investment multiplier is crucial for policymakers and economists to predict the repercussions of alterations in investment levels accurately.
Explaining the Investment Multiplier:
- Graphical Presentation:- The multiplier is depends upon the marginal propensity to
consume (MPC). If the MPC is higher, the size of multiplier would be
higher and vice versa. The concept of multiplier can be explained with the
help of following diagram.
In the above diagram, OX axis represents income and OY axis represents investment, consumption expenditure and savings. 450 line is known as consumption line. C+I is the initial investment curve which intersects ON line at E1 point. When the investment is C+I the national income is OY1. When there is an increase in investment from C+I to C+I1 the national income would rise from OY1 to OY2
- Working of the Multiplier :The multiplier operates on the principle that an initial increase in investment triggers a chain reaction of spending and income generation. As individuals receive additional income, they tend to spend a portion of it on consumption goods, leading to further income generation for others. This cyclical process continues, amplifying the impact of the initial investment on the overall economy. This is shown in the following table, how there would be a multiplication in income according to income propagation assuming that MPC is half or 50% of the income with the initial investment of Rs. 200 crores
Calculation of the Multiplier: The investment multiplier, denoted as ‘K’, is calculated as the ratio of the change in income to the change in investment. It quantifies how much the national income will increase in response to a specific change in investment. The formula for the multiplier is K = ΔY / ΔI, where K represents the multiplier, ΔY is the change in income, and ΔI is the change in investment.
- Reverse working of the Multiplier: In the reverse scenario, a decrease in investment can lead to a multiple decrease in aggregate income. This reverse operation of the multiplier demonstrates how changes in investment levels can have significant repercussions on income and employment. A reduction in investment can trigger a downward spiral effect on income levels, showcasing the sensitivity of the economy to investment fluctuations. This is shown in the following figure with the help of saving and investment curves.
- Assumptions: The concept of multiplier is based on the following assumption:-
1. The value of multiplier depends upon increase in investment.
2. It is assumed that the increase in investment has not further indirect effects on investment.
3. The calculation of multiplier depends on the assumption of a closed economy.
4. The MPC is constant.
5. There exists unemployment in the economy.
6. There is absence of multiplier period.
7. Keynes has assumed that, change in investment is of autonomous and not induced type.
8. It is assumed that the consumer goods are regularly made available.
- Limitations –
1. Availability of consumer goods – The theory assumes that multiplier depends upon the availability of consumer goods. The shortage of consumer goods will not increase the consumption expenditure. Ultimately it will reduce the magnitude of multiplier.
2. Full employment level – The multiplier works in the economy where the level of income is low and unemployment is high. Once the economy reaches the level of full employment the multiplier fails to work. At this level any increase in investment will not increase aggregate output and employment. This will limit the value of ‘K’.
3. Multiplier period – According to Keynes, when income of the people increases they spend a part of it on consumption and remaining amount is saved. But in reality there is time gap between the receipt of increased income and the expenditure on consumption. This time gap is called as multiplier period. The value of multiplier depends upon the
multiplier period of the time gap. Longer the time gap, the smaller will be the value of ‘K’ and the smaller the time gap, the larger will be the value of ‘K’.
4. Availability of resources – The concept of multiplier depends on the availability of resources for the production of consumer goods. But the shortage of resources will adversely affect the working of the multiplier and thus it will reduce the value of multiplier
Conclusion:–
Question 3:- Explain the calculation and leakages of investment multiplier
Introduction:
The calculation and understanding of the investment multiplier are crucial in macroeconomics to assess the impact of initial investment on the overall economy. By delving into the intricacies of how the multiplier is calculated and the potential leakages that can affect its effectiveness, economists can gain valuable insights into the amplifying effects of investment decisions.
Calculation of the Multiplier: The investment multiplier, denoted as ‘K’, is calculated as the ratio of the change in income to the change in investment. It quantifies how much the national income will increase in response to a specific change in investment. The formula for the multiplier is K = ΔY / ΔI, where K represents the multiplier, ΔY is the change in income, and ΔI is the change in investment. The following table indicate the different values of ‘K’ at different MPC figures And from this table it is clear that larger the MPC the greater
would be the value of ‘K’ and vice versa
- Leakages in Multiplier Process: The size or value of multiplier is reduced by the leakages in income stream on account of the following factors:-
1. Savings- In actual life the people does not spend the entire increase in income on consumer goods. On the contrary they save a part of it. The saved portion of increased income does not get converted in investment. This limits the value of ‘K’. Thus higher the propensity to save of the people lower shall be the value of ‘K’.
2. Repayment of old debts – The income recipients may repay their old debts to lenders instead of spending their income on consumer goods. The value of ‘K’ is reduced if lenders who receive this money from the borrowers do not spend it.
3. Accumulation of idle cash deposits- A part of increased income may be saved in the form of idle bank deposit instead of spending their income on consumer goods. The value of ‘K’ is reduced if the bankers who receive this money do not spend on consumer goods.
4. Purchase of old assets – The income recipients may buy old assets such as shares and securities from the people who may not increase their consumption. This will reduce value of ‘K’.
5. Excess of import – The import of foreign goods may be increase this will not help the domestic employment. This is because money is spent on foreign goods resulting in a net outflow of funds to foreign countries. This would reduce value of ‘K’.
6. Inflation – The rise in prices would reduce additional money expenditure even to buy same amount of goods and services. Hence actual consumption may not increase. This will reduce value of ‘K’.
7. High taxes – High rate of taxes may lead to decline in consumption expenditure and the value of ‘K’.
Conclusion:
The calculation and understanding of the investment multiplier, coupled with the identification of potential leakages, are vital for policymakers and economists. By recognizing and addressing factors that diminish the multiplier’s effectiveness, stakeholders can devise strategies to optimize the positive impact of investment on economic growth and stability. Through a comprehensive analysis of the multiplier’s calculation and leakages, economists can navigate economic complexities and harness the multiplier’s potential to drive sustainable development and prosperity. By delving into the intricacies of the investment multiplier’s calculation and leakages, economists can make informed decisions to leverage the multiplier’s amplifying effects on the economy effectively.
Important Note for Students :– Hey everyone! All the questions in this chapter are super important!