Page 113 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes
Example: Suppose the most profitable project pays 121, the next 116, next 111 and
the least profitable one only 106. If the rate of interest is 22% at present, none of the investment
will be profitable. At rates of interest between 16% and 21% only 1st project will be profitable,
at 18% 100 could be borrowed at a cost of 18: after one year, the investment would yield 121,
showing a profit of 3 after repaying the initial sum borrowed ( 100) and paying interest of
18. At rates between 11% and 16% the first two opportunities would be most profitable. A rate
below 11% makes the third project profitable. Similarly, a rate below 6% makes even 4th one
profitable. Thus, desired investment expenditure gradually rises from 100 to 200 to 300 and
ultimately to 400 on account of these four investment opportunities.
Thus the volume of investment varies inversely with rate of interest. So, the investment function
may be given as:

Here I is (autonomous) investment and r is the market rate of interest.

Thus, lower is the rate of interest, the larger the number of profitable investment opportunities,
and consequently the greater the investment expenditure that firms will like to make.
The exception is depression when there is widespread business pessimism. So investment
opportunities are lacking. At such times changes in 'r' are unlikely to affect investment decision
appreciably.
Table 6.1

Investment Disposable Income Change in Change in Income
Investment ( )
1000 0 - -
1000 1000 0 1000
1000 2000 0 1000
1000 3000 0 1000
1000 4000 0 1000
1000 5000 0 1000
1000 6000 0 1000
1000 7000 0 1000
1000 8000 0 1000
1000 9000 0 1000
1000 10000 0 1000
1000 11000 0 1000
1000 12000 0 1000
1000 13000 0 1000
1000 14000 0 1000
1000 15000 0 1000

Table 6.1 and Figure 6.2 show that the amount of investment does not change with changes in
income. It is autonomous - determined outside of the model. That is why there is no change in
investment as income changes. Because investment is not affected by changes in income, the
investment curve will have a slope of zero.

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