EXERCISE

1. Study the table below showing changes in the level of income, consumption
and saving in an economy and answer the questions that follow.
MPC = 0.8
Time Periods ∆ Y ∆C ∆S
(in ‘000 shs) (in ‘000 shs) (in ‘000 shs)
(spending periods)
A 100,000 80,000 20,000
B
C
D
Given that MPC IS 80% and the change in income is initially shs 100,000.
Calculate:
(i) Changes in income, changes in consumption and changes in savings for
time periods B, C and D (Show clear working)
(ii) The investment multiplier
(iii) The final change in national income if initial change In investment
spending is shs 100,000

2. Study the table below which shows the changes in the level of income,
consumption and saving in an economy for four rounds of spending.
MPC = 0.75
Time Periods Change in Y Change in C Change in S
(Spending periods)
1 200,000,000 150,000,000 50,000,000
2
3
4
Given that MPC is 75% and the initial change in income or investment spending is
shs 200,000,000. Calculate the following:
(i) Changes in income, consumption and saving for time periods 2, 3, 4
(ii) The size of the investment multiplier
(iii) Final change in income in the economy
 THE ACCELERATOR PRINCIPLE

It states that “When there is an autonomous change in consumption, it brings

about a greater than proportional change in the level of investment”.
It is observed from the accelerator principle that consumption tends to accelerate
(speed up) the level of investment. This is because an increase in consumption
increases the level of aggregate demand. As aggregate demand increases, firms
increase the level of output because of the assured market. Income levels also
increase leading to an increase in investment.

MEANING OF THE ACCELERATOR

The accelerator is defined as the number of times by which an initial change in

consumption is multiplied to give/ generate a final change in investment OR
The accelerator is the ratio of change in investment to the change in
consumption.
Change∈investment
Accelerator = Change∈Consumption

OR

ΔI
Accelerator = ΔC
EXAMPLE
Given that consumption expenditure increased from shs. 250 billion to shs. 400
billion and as a result, investment increased from shs. 600 billion to shs 900
billion. Calculate the accelerator

NB.

THE THEORY OF INVESTMENT

MEANING OF INVESTMENT
Investment is the process of creating capital stock (capital goods) in an economy.
OR
Investment is the process of devoting part of a person’s or nation’s income
towards creating capital stock (capital goods)
 THE NEED FOR INVESTMENT (REASONS WHY FIRMS MAY UNDERTAKE
INVESTMENT)
To increase (expand) levels of output in order to enjoy economies of scale.

To increase on the level of existing capital stock used in the production process.

To increase and maintain the level of profits.

To introduce new techniques of production i.e firms always plan to replace

labour intensive methods with capital intensive techniques of production. This
requires firms to purchase more machines in order to increase the level of output.

To produce a wider variety of products i.e to diversify production.

To undertake replacement of the worn out machines. This requires purchase of

new machines to replace the old ones.

To promote/ encourage exploitation of resources. This helps to minimize resource

wastage hence leading to high levels of production (high levels of economic
growth).

To improve entrepreneurship skills. Through investment, individuals are able to

develop their skills in risk taking as well as developing their ability to organize
other factors of production.

FACTORS THAT INFLUENCE/DETERMINE/AFFECT INVESTMENT

NB. We pick the points from the factors that influence capital formation. In the
explanation, we substitute the term capital formation with investment but we
show the two sides of how investment becomes high and how it becomes low.

 Level of entrepreneurship
 The existing land tenure system
 The existing capital stock
 The labour skills(size and quality of labour force)
 The level of income
 Government policy on taxes and subsidies
 The political climate
 The level of development of infrastructure
 The interest rate on loans
 Level of exploitation of resources
 The size of the market
 The state of technology(level of innovations and inventions)
 The rate of inflation/ price levels
 The level of marginal efficiency of capital
 The level of profits
 The degree of accountability/ level of corruption
 The population growth rate
 The time preference. Negative time preference leads to low levels of
current consumption. This brings about high levels of savings in the current
period hence high levels of investment. However, positive time preference
leads to high levels of current consumption. this leads to low saving and
low investment in the current period.
 The level of capital inflows and outflows.
 The level of saving.