Finance, Investments
Investment: investment multiplier. The effect of the investment multiplier
Consumption is the most important component of the total expenditure of society. This concept is understood as the costs of the population, which are aimed at the acquisition of goods and services of final consumption. The level of consumer spending is affected by many factors. One of those is investment. The investment multiplier is a coefficient that shows the change in the gross product together with them.
The first multiplier formulas
Keynes related the explanation of the extreme propensity to consume with the theory of the multiplier. His idea was created by Professor R. Kahn in 1931. He believed that costs (for example, the organization of public works) are the beginning to create "primary" employment, and also cause the purchasing power of workers and companies that are involved in the implementation of this activity. They create a new demand, which becomes a source of "secondary" employment.
In this case, new expenses will only occupy a part of the incomes of workers or companies, and the remaining funds will be involved to pay debts or postponed. According to Kahn, the multiplier depends on the amount of money spent at each new stage. Thus, the investment multiplier was created, the formula: K = 1 / (1 - K). This idea was developed by Keynes. His multiplier showed the dependence of national income on attracted investments - (K = DY / DI). It was introduced as a quantity that depends on increased propensity to consume. If we consider that Y is the national income, I is investment, C is consumption, and a is the propensity to consume, then the formula will be as follows: DY = DC + DI; DY = ax DY + DI; DC = DY xa; DY = DI (1 - a); DY / DI = 1 / (1 - a) = K> 1, if 0
The growth and reduction of income will be more significant if the changes are caused by investments. This result can be encountered by considering a numerical example. Suppose, initially, the volume of investments (I0) is 100 (billion rubles), and the consumption function is presented in the following formula: C = 20 + 0.6 x Y. In the ordinary state, the equation has the form: Y0 = 20 + 0,6Y x 0 + 100. That is, Y0 = 300 (billion rubles). If the amount of the initial deposit increases to 140 (I1), the equation will be Y1 = 20 + 0.6 x Y1 + 140. Hence Y1 = 400 (billion rubles). It can be concluded that their growth by 40 billion rubles. Led to an increase in income by 100 billion rubles. It is this phenomenon that is called the effect of the investment multiplier. One of the components of total costs is investment. Under them most often understand the contribution to the increase of the real capital of society. Most often they are long-term investments. The degree of net spending on them depends on two main factors. The first is the expected rate of net profit, which should be received by entrepreneurs from the expenses. The second factor is the interest rate. Entrepreneurs producing investment goods will receive more revenue in the event of an initial increase in investment. When you study the indicators, determine the multiplier will not be difficult. Profit is the motive for making investment costs. That is, the entrepreneur will only make purchases if they are expected to be profitable. You can consider a specific example. The owner of the furniture workshop wants to invest in a new grinding machine. Its cost is 2,000 rubles, and the service life is 1 year. The production of the workshop must be increased, and, consequently, the revenue. We can assume that the net expected income is 2500, that is, the investment multiplier is 2.5. Another component of spending is related to investment. This is the interest rate, that is, the price that the entrepreneur will pay for the money loan required to purchase the grinding machine. Investing will become profitable if the interest rate is less than the expected rate of net profit. It is worth noting that a significant role is played not by the nominal but by the real interest rate. By increasing investment, the investment multiplier will show changes in the national income per unit. Keynes calculated that this figure is 2.5 for the US and UK economies. The action of one-off investments will continue until the technological innovation that is associated with it is exhausted. For this reason, long-term investments are more profitable. If 0 Changes in profits will be caused not by savings, but by investments. Keynes showed how savings are created to achieve the required level of investment. This procedure is performed through multipliers. The scientist took all costs of the entrepreneur to purchase equipment for productive expenses. It is necessary to calculate the ideal efficiency of capital, as well as calculate the profit. The structure of investments is of considerable importance in this case. This is due to the fact that the entrepreneur hopes to profit from his capital for a long time. Keynes ratio of profit and salary decides in favor of the first. The producer can effectively apply liquid funds in the event that the rate of interest is less than the rate of return expected from the investment. A scientist determines the rate of interest as a fee for breaking up liquidity. In his opinion, it depends on a subjective assessment of the current and future economic conditions. In this case, investment will become more affordable, as the supply of capital will increase in liquid form. At the same time, the issue of money will cause a rise in prices and reduce the increase in liquidity, as their purchasing power will decrease. Demand for money can become unlimited with a fairly low interest rate. Keynes denies that the structure of investment can change under the influence of the rate of interest, which is also not able to change the investment plans of entrepreneurs in general. Keynesian school studies investment, investment multiplier, and creates practical recommendations. On their basis, social programs were created, which received funding from the budget, measures were taken to organize large public works, etc. The investment multiplier allows to maintain an effective demand in the event of crisis phenomena in the economy, and also has a positive impact on the economic situation as a whole. The effect of the investment multiplier
Investment: investment multiplier
Expected net profit margin
Real interest rate
Change in national income
The rate of interest and its impact on investment
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