Open In App

Investment Function: Induced Investment, Autonomous Investment and Determinants of Investment

Last Updated : 06 Apr, 2023
Improve
Improve
Like Article
Like
Save
Share
Report

What is Investment Function?

A strategy or concept of economics that helps in identifying the connection between shifts in the investment patterns of people and other variable factors affecting investment in an economy is known as Investment Function.

The expenditure incurred to create new capital assets is known as Investment. These capital assets include buildings, machinery, raw material, equipment, etc. The expenditure on these assets results in an increase in the economy’s productive capacity. The investment expenditure can be classified under the heads:

  • Induced Investment
  • Autonomous Investment

1. Induced Investment

The investment which depends upon the profit expectations and has a direct influence of income level on it is known as Induced Investment. Induced Investment is income elastic. It means that the induced investment increases when income increases and vice-versa.

Induced Investment

 

The above graph shows that the induced investment curve II has an upward slope from left to right. It indicates that as the income increases from OY to OY1, the investment also increases from OM to OM1.

2. Autonomous Investment

The investment on which the change in income level does not have any effect and is induced only by profit motive is known as Autonomous Investment. Autonomous Investment is income inelastic. It means that if there is a change in income (increase/decrease), the autonomous investment will remain the same. In general, autonomous investments are made by the Government in infrastructural activities. However, a country’s level of autonomous investment depends upon its social, economic, and political conditions. Therefore, the investment can change when there is a change in technology, or there is a discovery of new resources, etc.

Autonomous Investment

 

The above graph shows that the amount of investment remains the same, i.e., OI, no matter whether the income level in the economy is OY or OY1

Difference between Induced Investment and Autonomous Investment

Basis

Induced Investment

Autonomous Investment

MeaningIt is the investment that depends upon the profit expectations and has a direct influence on income level on it.It is the investment on which the change in income level does not have any effect and is induced only by profit motive.
MotiveThe motive behind induced investment is profit. It means that it depends on profit expectations.The motive behind autonomous investment is social welfare.
Income ElasticityInduced Investment is income elastic. It means that the induced investment increases when income increases and vice-versa.Autonomous Investment is income inelastic. It means that if there is a change in income (increase/decrease), the autonomous investment will remain the same.
Investment CurveAs induced investment is income elastic, its curve slopes upwards.As autonomous investment is income inelastic, its curve is parallel to X-axis.
SectorIn general, induced investment is done by the private sector.In general, autonomous investment is done by the government sector.
Relation with National IncomeInduced Investment is positively related to national income.Autonomous Investment is unrelated to national income.

Determinants of Investment

As per Keynes, the decision to invest in a new project or private investment depends upon two factors; i.e., Marginal Efficiency of Investment and Rate of Interest.

1. Marginal Efficiency of Investment (MEI):

MEI is the expected rate of return from an additional investment. The following two factors are required to determine MEI:

  • Supply Price: It is the production cost of a new asset of that kind. Simply put, the supply price is the price at which one can supply or replace the new capital asset. For example, if old equipment is replaced by equipment of ₹20,000, then ₹20,000 is the supply price.
  • Prospective Yield: It is the net return or net of all costs, which is expected from the capital asset over its lifetime. For example, if the equipment of ₹20,000 in the previous example is expected to yield receipts of ₹2,500 and the running expenses will be ₹500, then the prospective yield will be ₹2,500 – ₹500 = ₹2,000. 

The Marginal Efficiency of Investment (MEI) of the given equipment will be: \frac{2,000}{20,000}\times{100}=10\%

2. Rate of Interest (ROI):

It is the cost of borrowing money for financing investment. There is an inverse relationship between ROI and the volume of investment. If the Rate of Interest is high, then the investment spending will be less and if the Rate of Interest is low, then the investment spending will be more.

Comparison between MEI and ROI

To know about the profitability of an investment, a comparison between MEI and ROI is done. If the Marginal Efficiency of Investment is more than the Rate of Interest, then the investment is profitable, and if the Marginal Efficiency of Investment is less than the Rate of Interest, then the investment is not profitable. For example, if a businessman has to pay 10% rate of interest on the loan and the MEI or expected rate of profit is 15%, then the businessman will surely invest and will continue to make the investment till the Marginal Efficiency of Investment becomes equal to Rate of Interest.


Previous Article
Next Article

Similar Reads

Difference between Induced Investment and Autonomous Investment
Induced Investment and Autonomous Investment are two types of investment expenditure. What is Induced Investment? The investment which depends upon the profit expectations and has a direct influence of income level on it is known as Induced Investment. Induced Investment is income elastic. It means that the induced investment increases when income
2 min read
Balance of Payments: Surplus and Deficit, Autonomous and Accommodating Transactions, Errors and Omissions
A balance of payment (BoP) is a summary statement that lists all of the transactions that took place within a specific period between the resident and the outside world. The Balance of Payment indicates the extent to which a country saves enough money to cover its imports. It also reveals whether the country produces adequate economic output to fun
14 min read
Investment Decision: Meaning and Factors affecting Investment Decision
What is Investment Decision? Investment decision refers to the decisions that involve the investment of various resources of the firm to gain the highest possible return on investment for their investors. An investment decision is categorized as a long-term and short-term investment decision. Financial Management is concerned with the management of
4 min read
Theory of Supply: Characteristics and Determinants of Individual and Market Supply
What is Supply? The amount of a commodity a company is willing and able to provide for sale at a specific time is called the supply. The four factors highlighted by the definition of supply are quantity of commodity, price of the commodity, period, and willingness to sell. Characteristics of Supply The characteristics of Supply are: 1. Supply is a
6 min read
Price Elasticity of Supply : Type, Determinants and Methods
The Law of Supply states that, with other factors being constant, the quantity supplied increases with a price increase and decreases with a decrease in the price of the commodity. The degree of change in quantity supplied in response to changes in price is known as Price Elasticity of Supply. Price Elasticity of supply undertakes how the supply of
7 min read
Theory and Determinants of Demand
In economics, demand is the quantity of a good or service that a consumer is willing and able to purchase at different price levels available during a given time period. Although the demand is the desire of a consumer to purchase a commodity, it is not the same as desire. Desire is just a wish of a consumer to purchase a commodity even though he is
7 min read
Determinants of Personality
What is Personality? Personality can be described as a rich tapestry of inner psychological characteristics that both mould and mirror an individual's thoughts and behaviours within their surroundings. These inner traits encompass a diverse array of qualities, attributes, traits, factors, and mannerisms that set one person apart from another. Perso
5 min read
Insurance Premium : Works, Types, Calculation & Determinants
What is Insurance Premium?An insurance premium is the price you pay for an insurance policy, essentially the cost of transferring risk to the insurance's respective company. In exchange for your regular payments, the insurance company agrees to financially compensate you in case of unforeseen events covered by your policy, like accidents, illnesses
8 min read
Return on Investment (ROI): Meaning, Formula, Significance and Illustrations
What is Return on Investment (ROI) ? Return on Investment (ROI) is a measure that is used to estimate the amount of profit that can be earned or has been earned from the different types of investments. It not only determines the profit but also the loss generated on the investments. In other words, ROI lets you know how much returns you get on your
3 min read
Angel Investment : Meaning, Working and Types
Angel Investment refers to the financial support provided by individuals, known as 'Angels', to startup companies in exchange for ownership equity. Angels typically offer more flexible terms as compared to traditional funding sources and often play a mentorship rope in addition to providing capital. This form of investment is crucial for many start
9 min read