Friday, April 8, 2011

Investment - An Overview

Investment Function

National income is denoted by Y. It has two components, consumption(C) and savings(S). A part of the income is spent on consumption. That which is not spent is obviously saved. It may or may not be invested.

So we can say that Y = C + S

C is the supply of consumption goods and S is the supply of savings. This is the supply side of the picture.
National income is basically the money value of all goods and services produced in an economy during an accounting year. Total goods produced or total production is the sum total of consumption goods and capital goods. The total expenditure of the community is denoted by E. It means aggregate expenditure or effective demand. Aggregate expenditure is called effective demand because whatever is spent must be backed up by an equivalent demand.

So we can also say that E = C + I

C is the demand for consumption goods, or expenditure made by the household sector. I is the demand for investment made by the private firms. This is the Demand side of the picture.

National Income is said to be in equilibrium when the country spends as much as it earns, or when income is equal to expenditure. That means when the supply side Y = the demand side E.

Y = E Or, C + S = C + I

C cancels out from both the sides of the equation, leaving S and I on either side, which are equal.

That is, S = I. So the major point is that Savings (S) is equal to investment (I), only when the national income is equal to national expenditure. Gross national income is the money value of Gross National Products (GNP).

Investment is the second broad component of GNP. Although savings = investment, there is a relationship between savings and investment. Savers save more when the rate of interest is high, and investors invest more when the rate of interest is low. Although savings is equal to investment, savings is positively related to rate of interest, and investment is negatively related to it.
Definition: Investment refers to the change in the stock of capital either of the economy or of a business firm between two periods.

Dual Aspects of Investment: Investment is a form of expenditure and a source of demand. We know that E = C + I. Investment also shows the change is the stock of supply of capital. By adding to society's stock of capital, we enable it to produce more of both consumption goods and capital goods in future.

Gross Investment and Net Investment

Here D means depreciation. Gross investment less depreciation provides us with net investment or net capital formation.
Depreciation is defined as the reduction or depletion in the value of an equipment due to its contribution to the production process. It includes normal wear and tear.

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