This unit discusses the concept of investment with special reference to graphical and functional analysis. It also explored the relationship between the saving function and the investment function.
At the end of this unit, the student should be able to;
i. Recognize both saving and investment function.
ii. Understand Relationship between investment and saving.
iii. Know those factors that determine investment.
iv. Understand the functional and graphical illustration of investment
INVESTMENT CONCEPT: AN OVERVIEW
In ordinary parlance, investment means to buy shares, stocks, bonds and security
which already existing in stock market. But this is not real investment because it
is simply a transfer of existing assets. Hence this is called financial investment
which does not affect aggregate spending. In Keynesian terminology, investment
refers to real investment which added to capital equipment. It leads to increase in
level of income and production by increasing the production and purchase of
capital goods. Investment thus includes new plants and equipment, construction
of public work like dams, roads, building, etc., net foreign investment, inventories, and stocks and shares of new companies. In the words of Joan Robinson, ―by investment is meant an addition to capital, such as occurs when a new house is built or a new factory is built. Investment means making an addition to the stocks of goods in existences.
Capital, on the other hand, refers to real assets like factories, plants equipment,
and inventories of finished and semi-finished goods. It is any previously
produced input that can be used in the production process to produce other
goods. The amount of capital is a stock concept.
To be more precise, investment is the production or acquisition of real capital
assets during any period of time. To illustrate, suppose the capital assets of a firm on 31 march 2010 are N100 and it invest at the rate of 10% during the year
2010-2011. At the end of the following year (31 march 2011), its total capital
will be in year t, then 1t= Kt - Kt-1.
Moreover, when consider the relationship between investment and interest rate,
in Classist term, it could be found that there exist an inverse relationship between investment and interest rate, that is, when interest rate is low investment will be
high and vice versa, this is known as marginal efficient of investment (MEI), that is, rate of investment returns is subject to law of variable proportion. However, when this is held constant there would be shift in investment curve owing to other factors other than rate of interest.
Shifts in investment demand
The investment demand function was drawn on the assumption that other non�interest determinations of investment are held constant. Let us now relax that
assumption and examine forces that can shift MEI either to the left or to the
right.
The factors include:
Stock of Capital Goods Already on Hand
If a firm is operating with excess capacity or has accumulated some inventory, it
is not likely to increase its demand for investment. This is because any short�term increase in demand can be met either by running down the inventory or
using the excess capacity to increase production. In general, possession of a stock of capital goods will tend to shift MEI to the left, and the lack will shift it
to the right.
Cost of New Capital Goods
The purchase,, maintenance and operating costs of capital goods will affect the
rate of profit, hence shift the investment demand curve. If these costs are high,
investment will be discouraged and if they are low, investment will be encouraged.
Taxes
Tax is a cost of business. High profit tend to discourage investment while a
reduction in taxes tends to encourage investment.
Expectations
Business typically undertake investment under uncertainty. The uncertainty is
particularly relevant when some projects take a considerable length of time to
mature. A person‘s perception of the economic future greatly influences the
willingness to invest. Optimizing in terms of political stability, increase in demand, etc., tends to increase investment. Pessimism tends to reduce willingness to invest.
Technological Change
Changes in technology through new discoveries, inventions and innovations
encourage new investments. For example, the introduction of high yielding cereals and tree crops has encouraged more farmers to invest in modern farming
in Nigeria.
Increase in GDP
Investment is linked to GDP growth since it depends on aggregate demand.
Thus, a fast growth in GDP will exert pressure on aggregate demand, which in
turn will encourage investment. In this case, the growth in investment demand is
often faster than the growth in output. This relationship is referred to as the
acceleration principle. A low growth rate, however, will cause investment demand to shift to the left.
Self Assessment Exercise
i. Explain clearly you understanding of Business investment expenditure
INVESTMENT FUNCTION AND GRAPH
Fig: 3.1.1a The Investment Curve
Figure 3.1.1a shows that the level of investment spending is autonomous. i.e. it remains at the same level irrespective of income levels. Suppose I0 = 2000. At Y1
and Y2, I0 remains at 2000. This means that investment spending is independent
of income changes, ceteris paribus.
Figure 3.1.1b: The total investment Curve (induced plus autonomous
investment)
The figure 3.1.1b above, represent the total or aggregate investment where I0 is
the autonomous and iY is the induced investment that is income elastic.
Self Assessment Exercise
i. Graphically explain and illustrate the investment function
Relationship between Savings and Investment.
Saving and Investment are jointly influence by the level of income, both on
aggregate and individual household level. Saving is primarily determined by
level of income, same to investment. These two variables are majorly linked
together through aggregate level of income or household income on a
microeconomic level.
The algebraic relationship can be explained as follows:
S = f(Y) ...............1
I = f(Y, r) .................2
Y = C + I ................3
Y = C + S .................4
From the above, equation 1 ... 3, imply that, saving, consumption and investment
are respectively a function of income, while equation 5 and 6, simply expressed
the fact that income earned is either consumed or invested, similarly, income
earned is also consumed or saved.
Equality of Saving and Investment
Equate equation 3 and 4 above to have the following;
C + I = C + S ..............................5
Collect like terms to have the following equation;
C – C = S – I ..............................6 then
0 = S – I ...................................,7 therefore
S – I = 0 imply S = I................8
Equation 8 is the require classical saving – Investment equality.
Self Assessment Exercise
i. In a clear term establish relationship between saving, consumption and investment.
CONCLUSION
This unit discussed the concept of investment expenditure to the students, under which different definitions of investment is put into use as well as the
determinants of investment. Also two major types of investment were discussed
and the function forms of these two types of investment were explained with curves. Students are also introducing to the concepts of average and marginal propensity to invest
SUMMARY
This unit looked at concept of investment which include the explanation of
investment expenditure concept and graphical illustration of investment function.
It equally proof the classical equality of saving and investment at equilibrium.
MARKED ASSIGNMENT
i. What is aggregate investment expenditure
ii. Evaluate the relationship between saving and investment
iii. Explore the classical equilibrium of saving and investment.
iv. Explain the difference between I = I0 and I = iY
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