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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.