CONCEPT OF INVESTMENT

This unit discusses the concept of investment with special reference to graphical and functional analysis. It also explored the relationship between the saving function and the investment function.

At the end of this unit, the student should be able to;

i. Recognize both saving and investment function.

ii. Understand Relationship between investment and saving. 

iii. Know those factors that determine investment.

iv. Understand the functional and graphical illustration of investment

INVESTMENT CONCEPT: AN OVERVIEW

In ordinary parlance, investment means to buy shares, stocks, bonds and security 

which already existing in stock market. But this is not real investment because it 

is simply a transfer of existing assets. Hence this is called financial investment 

which does not affect aggregate spending. In Keynesian terminology, investment 

refers to real investment which added to capital equipment. It leads to increase in 

level of income and production by increasing the production and purchase of 

capital goods. Investment thus includes new plants and equipment, construction 

of public work like dams, roads, building, etc., net foreign investment, inventories, and stocks and shares of new companies. In the words of Joan Robinson, ―by investment is meant an addition to capital, such as occurs when a new house is built or a new factory is built. Investment means making an addition to the stocks of goods in existences.

Capital, on the other hand, refers to real assets like factories, plants equipment, 

and inventories of finished and semi-finished goods. It is any previously 

produced input that can be used in the production process to produce other 

goods. The amount of capital is a stock concept.

To be more precise, investment is the production or acquisition of real capital 

assets during any period of time. To illustrate, suppose the capital assets of a firm on 31 march 2010 are N100 and it invest at the rate of 10% during the year

2010-2011. At the end of the following year (31 march 2011), its total capital 

will be in year t, then 1t= Kt - Kt-1.

Moreover, when consider the relationship between investment and interest rate, 

in Classist term, it could be found that there exist an inverse relationship between investment and interest rate, that is, when interest rate is low investment will be 

high and vice versa, this is known as marginal efficient of investment (MEI), that is, rate of investment returns is subject to law of variable proportion. However, when this is held constant there would be shift in investment curve owing to other factors other than rate of interest.

Shifts in investment demand

The investment demand function was drawn on the assumption that other non�interest determinations of investment are held constant. Let us now relax that 

assumption and examine forces that can shift MEI either to the left or to the 

right. 

The factors include:

Stock of Capital Goods Already on Hand

If a firm is operating with excess capacity or has accumulated some inventory, it 

is not likely to increase its demand for investment. This is because any short�term increase in demand can be met either by running down the inventory or 

using the excess capacity to increase production. In general, possession of a stock of capital goods will tend to shift MEI to the left, and the lack will shift it 

to the right.

Cost of New Capital Goods

The purchase,, maintenance and operating costs of capital goods will affect the 

rate of profit, hence shift the investment demand curve. If these costs are high, 

investment will be discouraged and if they are low, investment will be encouraged.

Taxes

Tax is a cost of business. High profit tend to discourage investment while a 

reduction in taxes tends to encourage investment.

Expectations

Business typically undertake investment under uncertainty. The uncertainty is 

particularly relevant when some projects take a considerable length of time to 

mature. A person‘s perception of the economic future greatly influences the 

willingness to invest. Optimizing in terms of political stability, increase in demand, etc., tends to increase investment. Pessimism tends to reduce willingness to invest.

Technological Change

Changes in technology through new discoveries, inventions and innovations 

encourage new investments. For example, the introduction of high yielding cereals and tree crops has encouraged more farmers to invest in modern farming 

in Nigeria.

Increase in GDP

Investment is linked to GDP growth since it depends on aggregate demand. 

Thus, a fast growth in GDP will exert pressure on aggregate demand, which in 

turn will encourage investment. In this case, the growth in investment demand is 

often faster than the growth in output. This relationship is referred to as the 

acceleration principle. A low growth rate, however, will cause investment demand to shift to the left.

Self Assessment Exercise

i. Explain clearly you understanding of Business investment expenditure

INVESTMENT FUNCTION AND GRAPH

Fig: 3.1.1a The Investment Curve

Figure 3.1.1a shows that the level of investment spending is autonomous. i.e. it remains at the same level irrespective of income levels. Suppose I0 = 2000. At Y1 

and Y2, I0 remains at 2000. This means that investment spending is independent 

of income changes, ceteris paribus.

Figure 3.1.1b: The total investment Curve (induced plus autonomous 

investment)

The figure 3.1.1b above, represent the total or aggregate investment where I0 is 

the autonomous and iY is the induced investment that is income elastic.

Self Assessment Exercise

i. Graphically explain and illustrate the investment function

Relationship between Savings and Investment.

Saving and Investment are jointly influence by the level of income, both on 

aggregate and individual household level. Saving is primarily determined by 

level of income, same to investment. These two variables are majorly linked 

together through aggregate level of income or household income on a 

microeconomic level.

The algebraic relationship can be explained as follows: 

S = f(Y) ...............1

I = f(Y, r) .................2

Y = C + I ................3

Y = C + S .................4

From the above, equation 1 ... 3, imply that, saving, consumption and investment 

are respectively a function of income, while equation 5 and 6, simply expressed 

the fact that income earned is either consumed or invested, similarly, income 

earned is also consumed or saved.

Equality of Saving and Investment

Equate equation 3 and 4 above to have the following; 

C + I = C + S ..............................5

Collect like terms to have the following equation; 

C – C = S – I ..............................6 then

0 = S – I ...................................,7 therefore

S – I = 0 imply S = I................8

Equation 8 is the require classical saving – Investment equality.

Self Assessment Exercise

i. In a clear term establish relationship between saving, consumption and investment.

CONCLUSION

This unit discussed the concept of investment expenditure to the students, under which different definitions of investment is put into use as well as the 

determinants of investment. Also two major types of investment were discussed 

and the function forms of these two types of investment were explained with curves. Students are also introducing to the concepts of average and marginal propensity to invest

SUMMARY

This unit looked at concept of investment which include the explanation of 

investment expenditure concept and graphical illustration of investment function. 

It equally proof the classical equality of saving and investment at equilibrium.

MARKED ASSIGNMENT

i. What is aggregate investment expenditure

ii. Evaluate the relationship between saving and investment

iii. Explore the classical equilibrium of saving and investment. 

iv. Explain the difference between I = I0 and I = iY

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