7. determinants of income and employment
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Determinants of Income andEmployment: Inducement to Invest
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Meaning
The purchase of new plant, equipment, andbuildings and the addition to inventories forfuture production are called investments,because only newly constructed or createdassets create employment or generateincome.
Investment, in the theory of income and
employment, means an addition to thenations physical stock of capital as well asany addition to the stock of finished goods.
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Types of Investment
Investment may be classified on the basis of thefollowing two sets- Private investment or Public investment
Autonomous investment or Induced investment
Private investment is such investment which isdone by the private individuals on private account.Private investors are influenced by profit expectationsand the rate of interest. On the other hand, Publicinvestment is done by government/ state or
local authorities, such as roads, irrigation etc. Here,profit motive does not enter into consideration. It isundertaken for social good.
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Types of Investment
Investment which is independent of the level ofincome is called autonomous investment.Such investment does not vary with the level ofincome. In other words, it is income inelastic. It
depends more on population growth andtechnical progress than on anything else. Forexample- Long range investment in houses,roads and other forms of public investments.
Investment which varies with the change innational income is called induced investment.
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Types of Investment
Changes in national income brings aboutchanges in aggregate demand which in turnaffects the volume of investment. Whennational income increases, aggregate demandtoo increases. Investment has to beundertaken to meet this increased demand. Itis income-elastic.
It is influenced by profit motive.
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Factors affecting investment
Inducement to invest depends on two factors- Marginal efficiency of capital (MEC)
The rate of interest
The yield expected from a new unit of capital is
called MEC. This MEC must never fall below thecurrent rate of interest, if investment to beworthwhile.
If the business expectations are good or if the
MEC is high, more investment will be made inspite of the high rate of interest. On the otherhand, depression will discourage investment evenif the rate of interest is low.
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Factors affecting investment
Other factors: Excess Capacity: If a firm has already excess
capacity and can easily handle increased future
demand, it will not go in for further investment to
increase its capital equipment. Technological progress: This also affects current
level of investment. A new invention may render the
present capital stock of a firm obsolete and
adversely affect its ability to compete. In this case,further investment will be called for.
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Marginal Efficiency of Capital
The marginal efficiency of capital is thehighest expected rate of profit which is likely
to be had by a marginal increase in the rate of
investment.
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Diminishing Marginal Efficiency of
Capital
As investment increases, the marginalefficiency of capital falls. There are two
reasons for this:
One, the installation of larger number ofsimilar machines leads to a reduction in their
prospective yield just as consumption of more
units leads to a decrease in marginal utility.
Secondly, the prices of such machines will goup as their demand increases.
Hence, MEC goes down as investment
increases.