Investment

Question 1

Define investment

Answer 1

Investment is expenditure by firms to increase productive capacity. It is a flow concept, and the most volatile part of national income.

Question 2

What is the multiplier?

Answer 2

The multiplier (k) can be defined as the number of times by which the change in income exceeds the size of the initial expenditure. When investment is injected into the economy, national income will increase. However, income will ultimately increase by a greater amount than the initial injection - a ripple effect.

The multiplier can be found using the equation: k = 1/1-MPC or k= 1/MPS or ∆Y = ∆I x k.

In reality, the multiplier effect will be smaller than is predicted in the model

Question 3

Define the accelerator theory.

Answer 3

The accelerator theory states that a relatively small increase in national income, can cause a much bigger percentage increase in investment. The accelerator can heighten a boom or deepen a recession.

It explains why investment is so volatile. The level of investment depends on the rate of change in NI, and as a result tends to be subject to substantial fluctuation.

(Assuming a constant capital-to-output-ratio).

Question 4

What factors cause a shift in the MEC curve? (Determinants of investments)

Answer 4

INTEREST RATES (will cause a movement along the investment curve)

What causes a shift in the Investment curve (derived from the MEC curve):

1. Expectations
2. Spare capacity
3. Technological innovations
4. Availability of finance
5. Multinational investment
6. Stability
7. The country’s stage of development
8. Trade union power.