MACROECONOMICS

SIMPLIFIED

Edilberto B. Viray, Jr. MAE

Lucky Raymundo M. Malveda, MAE
Ma. Jesusa Avila – Bato, MAE
 CHAPTER VII
The Investment
Function

ANVIL PUBLISHING INC., 2016

 CHAPTER VII: The Investment Function

 Investment:
A Determinant of Income  Determinants of Savings
 Investment Defined  Investment Demand
 Investment and the Determinants
Multiplier  Interest Rate
 Investment and Output  The Acceleration
 Basic Concepts Principle
 Investment and the Stock  Innovations
Adjustment Process
 Profit
 Saving as a Source of
 Expectations
Investment
 Savings Concept
 Saving-Investment
Equilibrium
 CHAPTER VII: The Investment Function

Investment Defined

Investment expenditure is a capital spending mainly

derived not from current income and consumption but
from accumulated savings and other sources external to
the circular flow. In other words, investment is the capital
expenditure on the purchase of physical assets such as
plant, machinery and equipment (called fixed
investment) and stocks (called inventory investments),
i.e., physical or real investment. In economic analysis,
investment relates specifically to physical investment.
CHAPTER VII: The Investment Function
 CHAPTER VII: The Investment Function
Investment and the Multiplier
 The following equations illustrate how the investment factor is
incorporated in the income function with the multiplier process:

Δy = IM
Δy = I + ΔC
since initially:
y=C
therefore:
y = C + ΔC + I
y=C+I
where:
y = income
C = consumption
I = investment
M = multiplier
Δ = change in
 CHAPTER VII: The Investment Function

Investment and Output

Basic Concept:

In general, business and household investments

increase the economy’s stock of capital and
total output whereas depreciation has the
opposite effect as it represents capital
consumption
 CHAPTER VII: The Investment Function

Investment and the Stock Adjustment

Process
Despite the investment-production
time lag, sustained investment
expansion can determine growth in the
capital stock and production level of a
firm or the aggregate economy over a
long period of time
 CHAPTER VII: The Investment Function

Savings as a Source of Investment

Savings Concept
Savings is the unspent portion of a
person’s (personal saving), company’s or
institution’s (retained earnings) income
during the period intended for spending.
(as in the case of a salaried employee who sets aside
portion of his half-month pay earmarked for the next
fifteen days or for emergency expenses).
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 = saving
Y = income
C = consumption
 Saving-Investment Equilibrium
The saving-investment equilibrium implies
that increasing, decreasing or maintaining the level
of investment expenditure will respectively increase,
decrease, or maintain the level of income and
savings assuming all other factors remain constant.
Hence, investment expenditures are equal to
savings at any income level. In real terms, the flow
of investment spending determines the stream of
income through time such that savings transformed
into investment and plowed back to the economy
which simply maintains the level of income.
Determinants of Savings

a. Price level - which can affect expenditures and savings.

b. Population growth - which may change the level of savings.
Depending on the well-being of the economy, experiencing rapid
population growth may force savings by sacrificing unnecessary
consumption
c. Income
d. Taxes - which can erode savings as it gets a slice of income
available for spending.
e. Interest rate on savings accounts may only have minimal effect
on the level of savings of households and businesses considering
that the desire to save is basically influenced by motives other than
earning interest.
 CHAPTER VII: The Investment Function

Investment Demand Determinants

A. Interest Rate

Interest rate is the particular amount of

interest which a household or business is
required to pay to a lender for borrowing a
particular sum of money to finance spending on
consumption and investment
CHAPTER VII: The Investment Function
 CHAPTER VII: The Investment Function

B. The Acceleration Principle

The principle states that the level of

investment is a function of desired changes in
output. This change in investment constitutes
a shift in investment demand curves from I1
to I2 as shown in Figure 7.2.
CHAPTER VII: The Investment Function
 CHAPTER VII: The Investment Function

C. Innovations
Innovation is the ‘introduction of an unfamiliar
product and untested technology; opening a country’s
product to markets and sources of raw materials not
previously encountered; and the setting up of a new
organization in any industry’. Innovation can create
demand for products including capital goods and usher
the acceleration process between income and
investment. In a more general way, innovation can
contribute to faster economic growth.
 CHAPTER VII: The Investment Function

D. Profit

Profit is the basic reason why a business

invests and, therefore, profit tends influence
business investments in the long run.
 CHAPTER VII: The Investment Function

E. Expectations

A businessman generally invests

because he expects a certain level of profit
given certain influence of the business
environment
CHAPTER VII: The Investment Function

End of Chapter VII