Thursday, August 27, 2009

Inducement to Investment

Investment which varies with the changes in the national income is called induced investment changes in national income bring about changes on aggregate demand which in turn affects the volume of investment. When for instance national income increases, aggregate demand for increases. Investment has to be undertaken to meet this increased demand. The induced investment is income-elastic. i.e. it increases as income increases and vice-versa.

Induced investment is investment not only in fixed capital but also in investment which is undertaken to enable the economy to produce a larger output in order to meet the increased demand.

Induced investment is made by the people as a result of changes in income level or consumption. It is also influenced by price changes, interest changes etc which affect profit possibilities. It is under taken for the sake of profit or income and it changes with a change in income. Thus induced investments is governed by profit motive. It is sensitive to changes in income i.e. it is income-elastic.

Income is shown a long OX and investment along OY. The investment curve II has been shown as rising upwards to the right. This means that as income increases investment also increases and as income decreases investment too decreases.


Broadly speaking, inducement to invest depends on two factors which are

(a) The marginal efficiency of capital and

(b) The rate of interest.

Suppose a man borrows money to invest. He will have to pay interest on the loan. But he expects profit from this investment. He must compare the rate of interest which be has to pay and the rate of profit that he expects to obtain. Obviously the rate of return or profit must at least be equal to the rate of interest, otherwise no investment will continue to be made. So long as the expected rate of profit exceeds the rate of interest, investment will continue to be made. The yield expected from a new unit of capital is called Keynes marginal efficiency of capital. This marginal efficiency of capital must never fall below the current rate of interest, if investment is to be worth while.

Hence the inducement to invest depends on the marginal efficiency of capital on the one hand and the rate of interest on the other. Of these two determinants of inducement to invest viz the marginal efficiency of capital and the rate of interest which is of great importance. The rate of interest does not quickly change, it is more or less sticky or constant. Hence the inducement to invest, by and large depends on the marginal efficiency of capital. If the business expectations are good or if the marginal efficiency of capital is high, more investment will be made in spite of high rate of interest. On the contrary depression or bleak prospects of profits will discourage investment, even if the prevailing rate of interest is low. Thus fluctuations in the marginal efficiency of capita.

There some other factors that affect investment. For instance if a fimr has already excess capacity and can easly handle increased future demand, it will not go in for further investment to increase its capital equipments.

Technological progress also affects current level of investment. For example a new invention may rander the present capital stock of a frim obsolete and adversely affect its ability to compete. In this case further investment will be called for.


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