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THE INVESTMENT
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FUNCTION Next
WHAT IS INVESTMENT? Slide 2
> Putting money into something with a
hope of short-term gain, with or
without through analysis, as gambling
or speculation.
> In an economic sense, an investment
is the purchase of goods that are not
consumed today but are used in the
future to create wealth. Next
BASIC CONCEPT OF INVESTMENT
Investment Expenditure
– It is a capital spending mainly
derived not from current income and
consumption but from accumulated
savings and other sources external to
the circular flow.It should be noted that
investment spending,which is for long-
term consumption, is not the
monopoly of business since
households and government do as
well. Next
INVESTMENT AND THE MULTIPLIER 2
The following equations illustrate how
the investmentfactor is incorporated in
the income function with themultiplier
process: Where:
y= Income
Since initially C= Consumption
y=C I= Investment
Therefore: M= Multiplier = Change
y=C++I
y=C+I
The equations further imply thatinves
directly proportional to income.
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INVESTMENT AND OUTPUT
BASIC CONCEPTS
– It is a capital spending mainly derived not from
current income and consumption but from
accumulated savings and other sources external to the
circular flow.It should be noted that investment
spending,which is for long-term consumption, is not
the monopoly of business since households and
government do as well.
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1.Even after total investment expenditure to meet
production targets has already been incurred, the
process of setting upand even testing the capital base
creates operational lags.
2. Every phase in setting up a capital base may not be
capableof independent utilization until the completion
of the other phases.
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INVESTMENT AND THE STOCK ADJUSTMENT
PROCESS
Despite the investment
–production time lag, sustained investment patterns
can determine trends in the capital stock and
production level over a long period. The following
framework illustrates investment-output relationship
assuming a short-run time frame, no investment-
production time lag, and constant capital output ratio.
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INVESTMENT AND THE STOCK ADJUSTMENT
PROCESS
= Stock of capital after depreciation and investment
= Initial stock of capital, i.e., before depreciation and investment
D = Depreciation
I= Investment
= Initial output from the capital stock, i.e., before depreciation and
investment
= Total output from the capital stock after depreciation and
investment
= Change in total output because of depreciation
= Change in total output because of investment Next
= Output-capital ration (Y/K)
SAVINGS AS A SOURCE OF INVESTMENT
SAVING CONCEPT
Savings – It is the unspent portion of income during the period
intended for spending.
Savings of the economy can be simply expressed as follows
assuming that it is the only determinant of the multiplier
.S = Y – C
Where:
S= Savings
Y= Income
C= Consumption
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SAVINGS - INVESTMENT EQUILIBRIUM
Going back to the new income equation,
Y=C+I
Y–C=I
S=I
Assuming that income is now fully generated, (S = I)means
completing the process of transforming the investment inflow
into savings outflow which graduallyreduces the additional
income that the system generates. Inessence, what goes in will
then come out of the circularflow in the forms of savings taxes,
and imports
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DETERMINANTS OF SAVINGS PRICE LEVEL
POPULATION GROWTH
PRICE LEVEL POPULATION GROWTH
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INVESTMENT DEMAND DETERMINANTS
THE ACCELERATION
INTEREST RATE PRINCIPLE
Investment demand is inversely The principle states that the level of
proportional to the interest rate level investments is a function of desired
with other factors as constant(ceteris changes in output.This change in
paribus) resulting in an investment investment constitutes a shift in the
demand curve that is downward investment demand curve.
sloping.
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INVESTMENT DEMAND DETERMINANTS
INNOVATIONS
It can create demand for products including capital goods and usher the
acceleration process betweenincome and investment
JOSEPH SCHUMPETER
A noted development economist incontemporary times.
Describes innovation as theintroduction of an unfamiliar product and
untested technology,opening a country’s product tomarkets and sources
of raw material not previouslyencountered and the setting up of a new
organization in any industry
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INVESTMENT DEMAND-SUPPLY & FOREIGN
BORROWINGS
Local supply-demand constraints may induce the economy to tap
external sourcesof funds which traditionally was the case in the
Philippines because of the unrealistic interest rate ceilings
pegged by thegovernment in the 70’s and 80’s.
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INVESTMENTAND THE BUSINESS CYCLE
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BUSINESS CYCLE CONCEPTS
RECOVERY
Increase in Real GNP.
Increases in employment, income, production,
capacityutilization, and price
BOOM - The peak of recoveries upturn
RECESSION - Follows recovery with reverse trendsin
employment, income, production, capacity
utilization, and price.
DEPRESSION - It is when the economy reaches the rock bottom.
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DURABILITY OF CAPITAL: A SOURCEOF
INSTABILITY
a) Price level is constant implying that variations in the desiredexpenditure
level indicate changes in the desired production level.
b) Ratio of expenditure to capital stock is equal to 2.
c) Price of capital is equal to 2.
d) Marginal propensity to consume is 0.50 and, therefore, themultiplier is 2.
e) Periodic replacement in the capital stock is 5.
f) Replacement of additions to the capital stock because ofdepreciation
only takes effect after 4 periods.
g) No investment-output time lag.
h) A change in the level of investment expenditure only affectsincome Next in
the subsequent period.
Slide 10
Studio Shodwe
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