Introduction Theoretical Theories Of Investment Economics Essay

Introduction Theoretical Theories Of enthronisation Economics EssayInvestment is a st consec set outgic variable in the determination of the level and growth of income. It has been delimit in various ways by various economic experts. Generally, it refers to any act of spending with a prospective yield. To the economist, it refers precisely to the process of roof formation whereby there is net addition to the existing assets including inventories and goods in the pipeline of production. It is the actual production of crownwork equipment, tools and other produced means of production. Investment might be majuscule formation Financial Capital and Physical or real capital. There be gross, net and autonomous giftitures whereGross Investment= Net Investment + Autonomous InvestmentAutonomous Investment as well as known as Government Investment refers to enthronisation which remains the same whatever the level of income. It refers principally to the investment made on ho using ups , roads, public buildings and other parts of Infrastructure made by the government.Moreover Gross investment is the amount that a political party has invested on an asset or business without taking factoring in dispraise into consideration. In other words it is the total amount of notes dog-tired for the creation of new capital assets like Plant and Machinery, Factory Building etc. It is the total expenditure made on new capital assets in a period.Furthermore in economics, Net Investment refers to an activity of spending which allow for cause an increase in the availability of intractable capital goods or means of production. It is the total spending on new fixed investment minus replacement investment, which simply replaces depreciated capital goods. In fact it is Gross investment less Capital Consumption during a period of quantify.Private Investment depends on various categories of variables. So various theories of investment have been presented and they are provided overl eaf-Fisher surmise of InvestmentThis supposition was developed in 1930. Fishers guess was originally developed as a theory of capital, but as he assumes that all capital is circulating, then it is just as proper to conceive of it as a theory of investment. It was provided by Fisher that during the production process, all capital is used up, such that a banal of capital K did not exist. In fact all capital is just investment.There was a reason imposed by Fisher stating that Investment in any given period of time volition yield outputs in the nest period. This is illust assessd through the comparability belowY2=F N,I1Y2 = Output in period 2I1 = Investment done in period 1N = advertizeAssuming a world with only two periods of time, t=1, 2. Investment done in period 1 yields output in period 2. Moreover Fisher assumes that labor is constantKeynesian TheoryThe Keynesian theory was developed after that John Maynard Keynes (1936) followed suit of the Fisher theory. Keynes stated th at there is an independent investment run short in the economy. An great aspect of the Keynesian theory is that although savings and investment must be identical, ex-post savings and investment decisions are made by contrasting decision makers and there is reason why ex-ante savings should equal ex-ante investment. jibe to Trygve Haavelmo (1960) The Keynesian approach places far less emphasis on the adjustment personality of investment. Instead, they tend to have a more behavioral take on the investment decision. Namely, the Keynesian approach argues that investment is simply what capitalists do. Every period, workers consume and capitalists invest as a matter of course. They believe that the main decision is the investment decision the capital stock just follows from the investment patterns rather than being an important thing that needs to be optimally decidedAccelerator Principle TheoryOver the past two decades, the acceleration ruler has played a vital role in the theory o f Investment. In fact, this theory was developed before the Keynesian theory however it became apparent after Keynes investment theory in the twentieth century. The accelerator is generally associated with the name of J.M Clark though it seems to have been first developed by the French economist Albert Aftalion. The basis of the accelerator principle is based on the fact that changes in factors affecting case income would affect investment. In other words, big percentages changes are witnessed due to small in consumer spending. This suit of investment is known as induced investment since it is induced by changes in consumption and income. Furthermore, the accelerator is just the numerical place of the relationship between the increases in investment caused by an increase in income. Normally, it allow for be domineering when national income increases. On the other hand, it might fall to zero if the national output or income remains costant.Neo-Classical TheoryIn 1971, the neocl assical approach which is a version of the flexible accelerator amaze was formulated by Jorgenson and others. flexile Accelerator theoretical account is a more general form of the accelerator model. It is assumed that firms will choose only a fraction, a, of the gap between sought after and current actual level of capital stock each period. The larger the gap between the desire capital stock and the actual capital stock, the greater a firms rate of investment. This is illustrated belowI = a K* -K-1I = planned net investment during period tK* = desired level of capital stockK-1 = current actual level of capital stock at beginning of period t (end of period t-1)a = adjustment factor, 0 The desired capital stock is proportional to output and the investors cost of capital which in turn depends on the legal injury of capital goods, the real rate of beguile, the rate of depreciation and the tax structure. It is important to note that most recent empirical works are based on Jorgens on investment function. In fact Jorgenson provides that a falloff in interest rate would cause an increase in investment by reducing the cost of capital.In 1967, Hall and Jorgenson provide the Hall Jorgenson Model of Investment. The model illustrates that the level of capital stock that is chosen by an optimizing firm depend on various economic features like the production function, depreciation rates, taxes, interest rates. In fact Hall and Jorgenson had used the neoclassical theory of optimal capital accumulation to analyze the relationship between tax policy and investment expenditures. They concluded that tax policy is very effective in changing the level and timing on Investment expenditures.Q theory of InvestmentThe Q theory of Investment, introduced by Tobin (1969) is a popularly accepted theory of real investment. In fact it is a basic tool used for financial market analysis.It is a positive function of Qwhich foot be defined as the ratio of the market apprize of the exi sting capital to the replacement cost of capital. Q can be defined as followsQ=Stock Value of Firm/Replacement cost of InvestmentQ is a barometer for investors as it tends to assess a firms prospect. When Q is greater than one, the firm would make surplus investment because the profits generated would be greater than the cost of firms assets. If Q is less than one, the firm would be better off selling its assets instead of trying to put them to use as the firms value is less than what it cost to reproduce their capital. The ideal state is where Q is approximately equal to one denoting that the firm is in equilibrium.The Q theory of investment can also depend on adjustment cost. Literature on this issue was done by Eisner and Strotz (1963), Lucas (1967), Gould (19678) and Tredway (1969). Later Mussa (1977), Abel (1979, 1982) and Yoshikawa (1980) showed that Investment is an increasing function of the shadow price of installed capital. This is such only when there are convex adjustme nt cost.Marginal Q Model of InvestmentMoreover Abel (1981) and Hayaski (1982) introduced the marginal q model associated with smooth convex costs of adjustments. They assume that capital market are perfect, such that investment is undertake until the marginal value of an additional unit of investment has decreased to the exact value of the riskless interest rate. Abel (1981) describes marginal q as The optimal rate of Investment is an increasing function of the slope of the value function with respect to the capital stock (marginal q). Abe states that an increase in any factors that affect price can cause an increase, a decrease or even do not affect investment rate. The effect will depend on the covariance sign of the price with a weighted fair of all prices. Hayaski (1982) provides that under linear homogeneity, marginal q is equal to average q. However when marginal q is not equal to average q, it is marginal q which is relevant for investment. In fact marginal q is just a stoch astic version of the Q theory of Investment.Neo-Classical theory and Q theory of Investment (Panageas 2005)According to Stravos Panageas (2005), the neoclassical theory provides that Investment and the stock market are linked through the Tobin q. This is because the net present value of the company is the value of the company, so when the stock market is rising, there should be an increase in Investment to equate the Q ratio. This involves speculation. Panageas (2005) states that If firms maximizes share prices, then Investment reacts to ruminate overpricing. However he also provides that when investment is controlled by shareholders, who do not have perfect access to the market, the link between investment and speculation will not hold. There might be costs to access the market like capital gains taxes, price pressure etc. The model used by Panageas also aid to distinguish between rational and behavioural theories of asset pricing anomalies.Models associated with non-convex costsT here are also models with Non-convex costs of adjustments. King and doubting Thomas (2006) states Non-convex adjustment costs imply distributed lags in aggregate series similar to thosegenerated by convex costs, because they stagger the lumpy adjustments undertaken by individual(a)firms in reception to shocks. These non- convex costs is linked with the investment theory. A number of influential partial equilibrium studies (Caballero and Engel, 1999 Cooper,Haltiwanger and Power, 1999 Caballero, Engel and Haltiwanger, 1995) have showed that these investments models cause great changes in investment shoot following large aggregate shocks.Theories of Interest RateThere is a vast spectrum of interest rate at a given period of time in a country. The interest rate will depend on several variables such as nature of loans, duration of loans, credit worthiness of borrower, plight purchase agreements. When those variables are held constant, the rate of interest or pure interest rate is obt ained. The most common theories used to explain interest rate determinations are the Loanable Funds Theory (Neo Classical) and the fluidness Preference Theory (Keynesian Theory). Furthermore the ISLM model is held for a fully integrated approach.Loanable Funds Theory/ Neo Classical TheoryWe will first consider the Loanable notes theory which is also known as the neo classical theory of interest. It was developed by the Swedish economist Knot Wickshell (1851-1926). The rate of interest is obtained through the petition and contribute of loans in the credit market. The demand for loan is mainly to invest, to consume and to hoard. Traditionally the demand thread will slope downward because a fall in interest rate will attract borrowings. The supply of loans comes from 4 important sources. These are saving, cant money, dishoarding and disinvestment. The supply curve will be upward sloping since a higher rate of interest will induce these sources to supply more loans. So according t o the Loanable funds theory, the rate of interest will be determined where these two curves intersect. This is shown belowRate of interestSLR1Q1DLFigure 1.1Loanable FundsAccording to figure 1.1, the equilibrium rate will be R1 and Q1 will be the amount of loan that are demanded and supplied. Interest rate either above or below the equilibrium rate will be restored to the equilibrium rate through upward and downward pressure. Changes in the demand and supply of loan will alter interest rate. For example, technological changes might increase the demand for loanable funds. So according to this theory, the rate of interest is the price that equate the demand for and the supply of loanable funds. liquid Preference Theory/Keynesian TheoryThe Liquidity Preference Theory was developed by Keynes. Keynes described interest rate as a stringently monetary phenomenon which is determined by the demand and supply of money. Keynes identified 3 reasons why people would prefer liquidity rather that assets. These areTransactions demand for moneyThe transaction demand is the demand to hold money in order to meet day to day transactions. The amount of cash which the individual will keep in his possession will depend on his size of his personal income and the length of time between his pay days.Precautionary demand for moneyThe precautionary demand is the demand to hold money in order to meet unforeseen events such as illness, being unemployed. The amount of money that the individual will hold for precautionary motives will depend on the individuals condition, economic and political conditions which he lives. The size of his income, nature of the person and foresightedness will also affects the precautionary motives of a person.Speculative demand for moneySpeculative demand is the demand to hold money as oppose to the holding of bonds. There is an opposite relationship between bonds and the rate of interest. When the price of bond tends to rise, rate of interest will fall due to the inverse relationship, so people will be buying bonds to sell them later when the price actually rises. However when bond prices are expected to fall leading to a rise in the rate of interest, people will sell bonds to avoid losses. According to Keynes, when the interest rate is high, speculative demand for money will be low and vice versa.The supply of money is the amount of money in circulation at a specified time period. It is the central bank which will be determining the supply of money. It is fixed at any given period of time. According to the Liquidity Preference theory, the rate of interest is determined where these two curves intersect as illustrated belowR1Liquidity Preference (LP)Quantity of moneyQ1Q2S2Rate of InterestS1R2Figure 1.2As illustrated by figure 1.2, the money supply is represented by S1Q1 along the LP function. The rate of interest will be R1 where the supply of money intersects the LP function. If there is an increase in the money supply to S2Q2, there wil l be an excess in the supply of money causing people to adjust their demand portfolio by purchasing bonds. The price of bonds will rise leading to a fall in interest rate to R2.Investment/Saving-Liquidity Preference/Money supply (IS-LM) ModelThe previous two theories does not take into consideration in changes in national income to affect the rate of interest. The IS-LM model is used to arrive at a determinate solution. In fact it is part of the Keynesian theory. In the IS-LM model, interest rate is the only determinant of investment. The IS-LM model assumes that a higher interest rate will result in lower investment and vice versa. In this model interest rate will change due to changes in factors like business activity, credit creation by a bank, confidence, the level of national debt, inflows of funds and even international forces. Keynes provided the investment schedule where interest rate is the only primary determinant of investment. The schedule shows the amount of investment that firms would carry out at each rate of interest.