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University Institute of Liberal

Arts and Humanities


BA LLB (Hons)
Course Name – Economics
Course Code – 21LAT162
Faculty Name – Anushruti Agarwal

TOPIC OF PRESENTATION: Investment DISCOVER . LEARN . EMPOWER


COURSE OBJECTIVES
The Course aims to:

This course discusses the preliminary concepts associated with the


1 determination and measurement of aggregate macroeconomic variable like
savings, investment, money and inflation.

It also helps in understanding of macroeconomic theoretical structure which is


2 considered essential for the proper comprehension of the different issues and
policies

The subject equips the students to understand systemic facts and latest
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theoretical developments for empirical analysis

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COURSE OUTCOMES
On completion, the students are expected to
CO Title Level
Number
CO1 Students will analysis macroeconomics or Understand
aggregative economics and establish the  
functional relationship between the large
aggregates
CO2 Students will able to understand that the
Macroeconomics now is not only a scientific  Analyse
method of analysis; but also a body of empirical
economic knowledge
CO3 Students will evaluate the Investment and Apply
Consumption pattern and its impact on the
economy 3
Introduction
• In general sense of the term, investment means spending money on
acquiring physical assets, financial assets and human capital that yield a
return over time. Acquiring physical assets takes the form of spending
money on land, building, machinery and equipment. Financial assets
include time deposits, shares, bonds, mutual funds. Human capital
formation involves spending money on higher education or professional
qualification or expertise in any field of knowledge. Even lending money on
interest is also a form of investment. We will confine to what is called
business investment', i.e., acquiring or buying physical or financial assets for
the purpose of making profit. In macroeconomics, investment means the
sum of the money spent by the business firms per unit of time to build
physical 'stock of capital'.
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Capital and Investment
• The terms 'capital' and 'investment' are two different concepts. While
capital is a stock concept, investment is a flow concept. Capital refers
to the capital accumulated over a period of time. The term capital
means stock of productive assets including : the stock of machinery
and equipment; residential land and building; inventories. Investment
refers to addition to the physical stock of capital. If capital is K then
investment is ∆K = I.

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Gross vs Net Investment
• The gross investment is the total expenditure on capital goods per
time unit usually one year. It consists of annual expenditure on plant,
building , machinery; residential land and building and inventories. In
other words, net investment equals gross investment less
depreciation.
• Depreciation includes not merely the part of the won out or used up
in the process of production, but also the obsolescence of capital.

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Autonomous and Induced
• For analytical purpose, investments are classified also as: (1)
autonomous investment, and (2) induced . The general form of
investment function is given as
• I = f(Y,i) with f(Y)>0 and f(i) <0 where Y = income, and i= interest rate 
• The investment caused by the increase in income (Y) and decrease in
the interest rate (i) is called induced investment.

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Autonomous and Induced
• Autonomous investment, on the other hand, is the investment caused by
the factors other than the level of income and interest rate. In fact, income
and interest rate are not the only determinants of investment. There are
other factors also, called exogenous factors. The exogenous factors include
such changes in the economy as: (i) innovations in production technique, (ii)
invention of new production process, (iii) invention or discovery of new raw
materials, (iv) invention of new products, (v) discovery of new markets, (vi)
growth of population and its spending power, (vii) expansion plan of the
business firms, (viii) increase in public expenditure, (ix) future expectations
of better business prospects, and (x) emergence of new entrepreneurs in a
dynamic economy. Investment Caused by these factors called autonomous
investment.
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MEC
• Keynes had suggested an alternative method of investment based on
Marginal Efficiency Capital. According to Keynes, marginal efficiency
of capital is that rate of discount which makes the present value of
series of annuities given by returns expected from the capital asset
during its life just equal to supply discounted suppose. MEC is also
called as Internal Rate of Return. It refers to the rate of profit
expected to be made from investment in certain capital assets.

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MEC
• MEC depends on cost of capital and prospective yields.
• It is the rate of discount which renders prospective yields from a
capital asset over its whole life period equal to the supply price of that
asset.

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• For example, suppose that an investment project costs C = Rs 100
million and is expected to yield Rs = 125 million at the end of one
year.
• MEC = r = (125/100) -1
• = 0.25 or 25%

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• Suppose, cost of an investment project is C and it is expected to yield
a return R for one year, then MEC can be
• MEC = R/1+r = C -------------------------1
• r is the rate of discount that makes the discounted value of R equal to
C.
• Value of r is the MEC or IRR
• r= (R/C) -1------------------------2

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• If a capital project costing C is expected to generate an income stream
over a number of years as R1, R2, R3 ……….Rn, then MEC can be
computed as

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Decision rule:
Once MEC or IRR is estimated, investment decision can be taken by
comparing MEC with the market rate of interest (i). The general
investment decision rules are: 
• If MEC > i, then the investment project is acceptable
• If MEC = i, then the project is acceptable only on non-profit
considerations
• IF MEC < i, then the project is rejected

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The MEC schedule gives the investment demand curve of an
individual firm. Given the MEC schedule and the mkt roi, firm’s
demand for capital can be known.

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• The conclusion that decrease in the interest rate will increase
investment along the MEC schedule holds in case of an individual firm
but not for the economy as a whole.
• The reason is that when interest rate falls demand for capital goods
increases. Given the production capacity of capital goods industry,
demand exceeds supply and price of capital goods increases.
Consequently, MEC decreases and MEC curve shifts leftward. It means
that total investment is less than expected from the fall in the interest
rate. The marginal efficiency of investment is the rate of return
expected from a given investment on a capital asset after covering all
its costs, except the rate of interest.
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• To explain the point further, an individual firm's capital stock can be
increased overnight to its desired level as its demand for capital goods
can be met from the inventories of the firms in the capital goods
industry.
• But inventories would fall too short of demand when all the firms plan
to increase their stock of capital to its desired level in one time
period. For example, if interest rate decreases from 14 percent to 10
percent, the desired stock of capital increases from Rs. 30 million to
Rs. 50 million.

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• That is, the desired level of capital stock increases by 66.67 percent. This increase
in capital demand can be met under only one condition that capital goods
industry has more than 70 percent of its production capacity unutilised and it can
increase its supply of capital goods (plant, machinery, equipment, etc.) in the
short run.
• This is generally not the case in reality. Under normal conditions, there cannot be
such a huge excess capacity in the capital goods industry. In fact, the production
capacity of the capital goods industry in the short run depends on and is limited
to the replacement demand for capital, market interest rate remaining
constant.

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Factors affecting Investment
• Increased Optimism among Managers:
If business managers are more optimist about the future, they will place more
orders for machines. This will enable them to make more profit by venturing out
in those areas where demand for consumer goods is picking up
• An Increase in the Growth Rate of the Economy:
Keynes assumed that all investment is autonomous and is thus independent of
national or per capita income.
So anything which increases the demand for consumer goods is always
beneficial for the capital goods producing industry. If India’s growth rate (as
measured by the annual rate of increase of per capita income) increases there
will be more demand for consumer goods such as food and textiles.
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So industries producing such goods will be stimulated and the managers of such
industries will place more orders for purchase of machines. In other words, there
will be more demand for food-producing and textile- producing machines.
This is because the demand for capital (investment) goods is a derived (indirect)
demand. In fact, the acceleration principle suggests that a small increase in the
demand for consumer goods leads to an accelerated increase in the demand for
capital goods.

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• An Increase in Capital Stock:
An increase in the society’s stock of capital—all other factors remaining
the same—will lead to a fall in the marginal physical product of capital
and will reduce the MEC by lowering the prospective rate of return on
new investment. So investment will fall.
• A Change in Technology:
A favourable technological change (which reduces cost of production)
will shift the MEC schedule to the right. So the volume of investment
will increase even if the rate of interest remains constant.

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• Changes in the Rate of Interest:
Economists differ in their views about the interest rate sensitivity of
investment. Some Keynesian economists argue that investment depends
largely upon expected return and is not much sensitive to interest rate
changes. This means that even large changes in interest rates have little
effect upon investment (the marginal efficiency of capital curve being
very steep). Thus the Keynesian economists claim that monetary policy will not be
very effective in influencing the level of aggregate investment in the economy. In
contrast the monetarists like Milton Friedman argue that investment is very much
interest rate-sensitive. So even small changes in interest rates will have significant
impact upon investment (the marginal efficiency of capital curve being quite flat).

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Assessment Pattern
Students are assessed on the basis of the following
parameters:
• Hourly Tests - 2
• Assignments
• Surprise Test
• Quiz
• Student Engagement
• End Semester Exam

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REFERENCES

Textbooks
• HL Ahuja – Macroeconomic theory and policy

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THANK YOU

For queries
Email: anushruti.e12418@cumail.in

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