Savings and Investment Relationship, Factors Affecting Investment

Wed, 06/20/2012 - 04:54 -- Umar Farooq

Savings and Investment Relationship

Here we will take investment in terms of a sche­dule giving various amounts of investment associated with various levels of income. The investment schedule is the function of entrepreneurial behavior. It tells us how the investors or producers respond to a change in income or in the interest rate over a given time propensity to invest together with propensity to consume determine the level of income.

The investment schedule may be compared with a demand schedule stating the functional relationship of capital outlay at various levels of income or investment. If investment depends upon income, it may be either

  • Induced Investment
  • Autonomous investment

Induced Investment

Induced investment is income-elastic because of short-term profits possibly due to increased demand, the investment curve slop­ing sharply from the horizontal income axis.

Induced Investment - Saving and Investment Relationship

In this figure curve I represent the induced investment schedule at various levels of income.

Autonomous Investment

Autonomous Investment is defined as income-in-elastic investment. It is insensitive to income changes. Autonomous investment is the phenomena commonly associated with a planned economy, where investment decisions are made irrespective of profit or losses. Here the investment curve runs parallel to the horizontal income axis. In other words investment remains constant regardless of income.

Autonomous Investment - Saving and Investment Relationship

In this figure the curve represents autonomous investment at various levels of income.

Logic of Saving and Investment

In the study of national income analysis that = Y or total income is equal to total expenditure. Since investment is expenditure on things other than consumption, so income minus consumption is investment or C I. In the case of savings, it is equal to income minus consumption or Y C = S. In both cases savings and investment are equal to income minus consumption, so we may say S=I. So it is statistically true that saving and investment are equal.

Factors Affecting Investment

The propensity to consume depends upon a number of factors. It is now necessary to understand the various influences on which the propensity to invest depends.

  1. Profitability and investment opportunities. Hope for profit is the care of business con­fidence. A businessman's expectation of profit leads to greater investment and the greater the investment opportunities and higher the rate of profit the larger the new investment will be.
  2. Tax Structure. The tax structure of a country should be such as to induce business­men to invest more. Tax holidays and specific tax reliefs are examples of incentives for investment.
  3. Wage Rate. Changes in wage rates may affect the propensity to invest. An increase in wage rates reduces the investment function, therefore businessmen argue against wage increases on the grounds of cost.
  4. Capital Accumulation. The production of real physical fixed capital i.e. plant, buildings, machinery etc. greatly affects investment decisions. Many economists believe that "abundance of capital" results in profitable investments. However the accumulation of capital does lead to new investments.
  5. Technological Developments.  Innovations and inventions are conducive to the pro­pensity to invest and it has been shown in the past that new inventions do lead to new invest­ments. Changes in technology are usually of a capital using character, requiring more capital per unit of output.
  6. Growth in population. Changes in population also affect long-term investment deci­sions. A growing population creates more markets and therefore tends to increase investments; a decline in population has the opposite effects. Changes in the composition of population also affect investment decisions. For example, if the standard of living of the people is improving there is a greater demand for housing, furniture, etc. and hence new investments.