Friday, April 8, 2011

Autonomous Investment

Autonomous investment is that investment which is independent of the national income. It takes place on its own, without bearing any relationship to Gross National Product or its rate of change. If we analyze the factors that govern autonomous investment, then we will clearly understand why it is autonomous. Autonomous investment depends upon two major factors.

1. Rate of Interest 2. Marginal Efficiency of Capital

1. Rate of Interest: Rate of interest is the cost of borrowing money in order to acquire an asset, or if funds are available, then the income or opportunity, in the form of interest, foregone to acquire the asset. The later is called the opportunity cost of investment.
Investment is inversely related to rate of interest. The higher the rate of Interest, the lower will be the level of autonomous investment. A fall in the rate of interest will bring in fresh investment. Fresh investment will increase income through the multiplier, and employment will consequently rise.

2. Marginal Efficiency of Capital: It is basically concerned with the rate of return from the investment. Investor's expectation from future earnings from the investment must always be greater that the cost of borrowing the necessary funds, required to acquire the asset. This expectation is largely dependent on present level of expenditure and consumption. If these are high, then the investor will have an optimistic view of the future. He will invest.

So long as the present value of future earnings from the asset is equal or greater than the acquisition cost of the asset, the producer will invest. Marginal efficiency is basically a rate, at which future yields, expected from one additional unit of an asset, must be discounted, so as to make the total yield at least equal to the acquisition cost of the asset.
Marginal efficiency of capital, within a given period of time, keeps on diminishing for any given kind of asset. This is because anticipated yields from the asset will diminish, as more and more of the asset in put into use. Secondly, the acquisition cost of the asset will increase as more and more of that asset is purchased by producers.

The concept of autonomous investment was developed by Mr. Keynes. He said that autonomous investment would be positive, so long as the marginal efficiency of capital is greater than the rate of interest. So long as mec > i, fresh investment will take place. If the market rate of interest remains unchanged at oi, and the marginal efficiency of capital starts falling with the application of more and more capital, a stage will be reached when when mec = i. This is shown by the point E, where the producer will reach his optimum level of investment. This occurs due to the Law of Variable Proportions.

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