Investment

 Investment pays two roles in

macroeconomics:
 It can have a major impact on AD (real output
and employment)
 It leads to capital accumulation (it increases
the nation's potential output and promotes
economic growth in the long run)
 Determinants of Investment

 Revenues: an investment should bring the

firm additional revenue.
 Costs: interest rate influences the costs of the
investment.
 Consumer demand: the bigger the increase in
consumer demand, the more investment will
be needed.
 Expectation: business expectation about
future state of economy.
 The Investment Demand Curve
Interest
rate i Higher Output

D1
D
Investment spending
 The Investment Demand Curve
Interest
rate i Higher Taxes

D
D1
Investment spending
 The Investment Demand Curve
Interest
rate i Pessimistic Expectation

D
D1
Investment spending
 The Simple Theory of
Investment
 In the simple Keynesian model,
investment is independent of national
income (autonomous investment).
 The investment function will be a
horizontal straight line.
 The Investment Function

I In the short-run it
is reasonable to
assume that
investment is
I2 independent of
I2 national income.
I1
I1

0 Y
 Consumption and Investment
Functions

 The spending curve shows the level of

desired expenditure by consumers (CA +
MPC.Y) and businesses (I) corresponding
to each level of output.
 Equilibrium National Income

C, I

C + I = CA + MPC . Y + I
E Consumption and
investment determine
output

45˚

0 Y1 YE Y2 Y
 The Multiplier Effect

 A change in investment spending

ultimately changes output and income by
more than the initial change in investment
spending. This is called the multiplier
effect.
TM – 103 Chapter 9
Table 9.3

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc. All Rights reserved.

 Investment Multiplier

 The Keynesian investment multiplier model

shows that an increase in investment will
increase output by a multiplied amount – by
an amount greater than itself.
 The multiplier is the number by which
the change in investment must be
multiplied in order to determine the
resulting change in total output.
 Investment Multiplier

C, I C + I2
E2 I2 = I1 + ΔI
C +I1
ΔY = k . ΔI
E1
ΔI Y
k 
I
45˚

0 Y1 ΔY Y2 Y
 Investment Multiplier

 The size of the multiplier k depends upon how

large the MPC is.

Y Y 1 1 1
k    
I Y  C 1  C 1  MPC MPS
Y