Determinants of Income and Employment: Inducement to Invest

Meaning
The purchase of new plant, equipment, and

buildings and the addition to inventories for future production are called investments, because only newly constructed or created assets create employment or generate income. Investment, in the theory of income and employment, means an addition to the nations physical stock of capital as well as any addition to the stock of finished goods.

Types of Investment
Investment may be classified on the basis of the following two sets Private investment or Public investment Autonomous investment or Induced investment

Private investment is such investment which is

done by the private individuals on private account. Private investors are influenced by profit expectations and the rate of interest. On the other hand, Public investment is done by government/ state or local authorities, such as roads, irrigation etc. Here, profit motive does not enter into consideration. It is undertaken for social good.

Types of Investment
Investment which is independent of the level of

income is called autonomous investment. Such investment does not vary with the level of income. In other words, it is income inelastic. It depends more on population growth and technical progress than on anything else. For example- Long range investment in houses, roads and other forms of public investments. Investment which varies with the change in national income is called induced investment.

Types of Investment
Changes in national income brings about

changes in aggregate demand which in turn affects the volume of investment. When national income increases, aggregate demand too increases. Investment has to be undertaken to meet this increased demand. It is income-elastic. It is influenced by profit motive.

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 the current rate of interest, if investment to be worthwhile. If the business expectations are good or if the MEC is high, more investment will be made in spite of the high rate of interest. On the other hand, depression will discourage investment even if the rate of interest is low.

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.

Marginal Efficiency of Capital

The marginal efficiency of capital is the

highest expected rate of profit which is likely to be had by a marginal increase in the rate of investment.

Diminishing Marginal Efficiency of Capital

As investment increases, the marginal

efficiency of capital falls. There are two reasons for this: One, the installation of larger number of similar 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 go up as their demand increases. Hence, MEC goes down as investment increases.