FINANCE-The most important determinant of an investment's portfolio risk - 00124564 Tutorials for Question of Business and General Business Use the following Consumption function data to answer the questions below: Real Disposable Income Consumption Saving MPC MPS $100 $150 $200 $200 $300 $250 $400 $300 $500 $350 A. At any fixed time, there will be some investment which is needed to replace worn-out capital. These are divided into two broad categories, viz., consumer goods and capital goods. This could induce firms invest their funds instead of lending them in the open market. This can be achieved through process of innovation, i.e., introduction of new production processes. 4. B) the foreign exchange rate. However, government investment is not influenced by these factors. 117147 Questions; 116084 Tutorials; 96% (5300 ratings) Feedback Score View Profile. Among other hallmarks of his economic theories, Keynes believed that governments should increase spending and lower taxes in order to stimulate demand in the face of recession. Consumer goods are those which satisfy wants directly. according to Keynes, the primary determinant of a person's saving is NOT D) the interest rate but the level of the person's real disposable income the consumption function shows how much So long as MEC ex­ceeds the rate of interest (r) new investment will take place and once MEC is equated to r no further in­vestment will occur, as indi­cated by point E. As Keynes has pointed out, “The amount of current invest­ment depends on the in­ducement to invest and the inducement to investment, in its turn, depends on the relation between the schedule of marginal efficiency of capital and the interest rates on loans of varying maturities and risks”. Hope of profit leads to demand for capital and more investment. Therefore, it is not a leakage. Question 4 1 pts According to Keynes, the MOST important determinant of business investment is _____. Entrepreneurs get more profit and, therefore, there occurs more investment. D) the level of investment. In a period of rising demand for goods and services existing capacity will be fully utilised and there will be need for fresh investment. b. Meade put it, “A greater amount of fixed capital should be invested so long as the annual interest on the capital plus the annual cost of repair, depreciation, etc. In many countries, rebates are given for new capital investment, e.g., advantages as regards rates of depreciation. Answer Save. 1) Solution: Disposable income Explanation: As per Keynes, disposable income is most vital determinant of household's spending on goods and services view the full answer Previous question Next question D. 0 0. Induced investment is influenced by endogenous factors such as income level, propensity to consume, stock of fixed capital, etc. 92. 1 Answer. And the most important factor in determining the volume of investment is the marginal efficiency of capital. However, Keynes became comparatively more radical later in life and began advocating for government intervention as a way to curb unemployment and resulting recessions. In fact, the rate of interest influences investments, because it represents the cost of borrowing. Answer: As tempting as some of the answers are the only correct answer is (d). Expenditure on producer goods is known as investment or capital formation. Stand-alone risk is relevant only for investments held in isolation. His theories of Keynesian economics addressed, among other things, the causes of long-term unemployment. The supply price of capital (i.e., its cost) may also rise but this is a short run factor. However, a more important concept to consider is the shift in the investment demand curve. However, there is an offsetting consideration. Get your answers by asking now. This relates the level of planned investment to the rate of change of income and consumer demand for the output of business firms. The Role of Savings 2. So, a firm has to make provision for depreciation, i.e., reduction in the value of capital goods due to their contribution to the production process. This simply means that at times of low economic activity with low levels of capacity utilisation there will be very weak relation between demand and investment. Various goods and services are produced by an economic system. Keynes’s critics, however, believe that savings generates funds available for borrowers in the financial markets, and eventually becomes another form of spending. Macroeconomics studies an overall economy or market system, its behavior, the factors that drive it, and how to improve its performance. The most important determinant of an investment’s portfolio risk is which of the following? d. disposable income. The most important determinant of an investment's ; rey_writer. So, the investment demand function and the volume of investment moves along with the increases or decrease in the MEC. In the equation C = 60 + 0.6 Y, MPC is A. Keynes believed that investment does not depend on the current level of income. It is likely to reduce the burden of debt- repayment and make it easier — at least for a time — for firms to widen profit margins following an investment. The speculative motive giving rise to the speculative demand for money is the most important contribution Keynes made to the theory of the demand for money. For these two reasons, economists believe that high and vari­able inflation has an adverse effect on investment. The profit from an investment is equal to the total revenue obtained from it minus the expenses, of which interest is a part. • Investment → savings via multiplier process • Inv not constrained by saving, but possibly by the availability of finance • Investment expenditures are the single most important determinant of fluctuations in GDP • Have strong non-rational component • … In fact, the greater the pressure and scope for increased efficiency, the larger the volume of investment firms are likely to undertake if they are to survive and expand. Any excess of gross investment over depreciation represents net investment in expanded capac­ity or net capital formation. Keynes, states that rate of interest is relatively constant in the short run, but MEC is highly fluctuating. This was the basis of Keynes belief that an increase in spending would, in fact, decrease unemployment and help economic recovery. This factor is especially important for the deepening of capital. John Maynard Keynes was born in 1883 and grew up to be an economist, journalist and financier, thanks in large part to his father, John Neville Keynes, an Economics lecturer at Cambridge University. The answer is A). 3. Lower wages provide profit opportunities. Which itself depends on business confidence. In Keynes time, the opposite was believed to be true. The price level. Capital goods wear out through use and have to be replaced. constant in his theory of consumption. According to Keynes the most important determinant of consumption A. Share Your PDF File But, in the long run, MEC declines. Disclaimer Copyright, Share Your Knowledge The interest rate. A study of the various theories brings into focus the main influences on the level of business investment which are the following: Ceteris paribus, higher profitability will improve the prospects for investment. e. investment f. capital inflows from abroad g. the stock of consumer wealth h. expectations about future prices and income i. the availability of credit and level of credit charges. d. Disposable income. Business firms make investment in the following three ways. The inducement to invest may be increased by lowering taxes. Keynes advocated that the best way to pull an economy out of a recession is for the government to borrow money and increase demand by infusing the economy with capital to spend. Another basic principal of Keynesian economics is that economies which invest more than their savings will experience inflation. Similarly, if an investment project does not return sufficient money it will turn out unviable. According to Keynes, what is the most important determinant of households' spending on goods and services? When business firms struggle to pay-off debts they have incurred in the past, their current investment levels fall. Debt levels of firms also influence invest­ment. However, marginal efficiency of capital is unstable in the short run and causes investment fluctuations. Welcome to EconomicsDiscussion.net! The offers that appear in this table are from partnerships from which Investopedia receives compensation. So, the higher their level the more funds become available for financing investment. At a fixed point of time, there will exist a range of potential investment projects over the economy, some expected to yield higher rates of return (in terms of profit), some lower costs and others possibly a loss. TOS4. Moreover, movement in interest rates can also influence investments by providing an indicator of likely future economic conditions. Conversely, a low rate of interest will make some investments attractive and the volume of investments will increase. After all, investment depends on business confidence. To survive in a competitive world, firms will be under constant pressure to raise productivity of resources, especially labour power. According to Keynes, the volume of investment depends on all other factors except national income. a. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. So, for a given acceleration of output, the larger is the inherited capital stock, the less will be the level of investment required for replacing or adding to existing capacity. He argued that a government jobs program, increased government spending, and an increase in the budget deficit would decrease high unemployment rates. Pulling In Their Horns: A collective shift by investors toward a less bullish stance after a substantial run-up in prices of financial assets. C) the individual's real disposable income. (2) Rate of interest: The amount of investment is influenced by the marginal productivity of capital and the rate of interest. Thus, anything which increases consumption demand, such as per capita income growth or even population growth is always good for industries capital goods producing. Before publishing your Articles on this site, please read the following pages: 1. Keynesian Theory of Income and Employment: Definition and Explanation: John Maynard Keynes was the main critic of the classical macro economics. (Points : 1.5) The variance of the investment's return distribution The standard deviation of the investment's return distribution The size of the investment John Hicks's 1937 paper Mr. Keynes and the "Classics"; a suggested interpretation is the most influential study of the views presented by J. M. Keynes in his General Theory of Employment, Interest, and Money of February 1936. Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level at a given time. Growth of population leads to higher demand for capital. Keynes' father was an advocate of laissez-faire economics, and during his time at Cambridge, Keynes himself was a conventional believer in the principles of the free market. It is not a function of income or its rate of change. Secondly, savers and lenders may need ‘risk premium’ in the form of higher interest rates, which will tend to reduce investment. Saving C. Income D. Investment 93. Content Guidelines 2. The word "investment" is being used in a Pickwickian, or Keynesian, sense. A high rate of inflation, when it is anticipated, can have favourable effects on investment. His career spanned academic roles and government service. However, it is a matter of great surprise that most study show little connection between investment and rates of interest. The public decisions include, most prominently, those on monetary and fiscal (i.e., spending and tax) policies. (vi) Consumption expenditure depends upon the size of income and the propensity of consume. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. According to Keynes (1964), investment is volatile because it is determined by the “animal spirits” of investors (optimism and 1 According to the European System of Accounts 1995 (ESA 95). There­fore, it leads to more investment. The main determinants of investment are: The expected return on the investment Investment is a sacrifice, which involves taking risks. According to Keynes, investment rate in the economy is mainly influenced by two factors, marginal efficiency of capital and rate of interest. (v) Aggregate demand function is governed by consumption expenditure and investment expenditure. b. If a firm is unable to make profit from its investment, it will not be able to retain a portion of its earning for expansion arid diversification. Rising interest rates may be a signal of government action to restrain the growth of demand — which could have an adverse effect on firms’ sales and returns. According to Keynes, the volume of investment depends on all other factors except national income. According to the classical theory there are three determinants of business investment, viz., (i) cost, (ii) return and (iii) expectations. At an anticipated rate of interest of 15%, however, the same project would become viable. Then, the net income which will probably be obtained by the owner is Rs 1,000, i.e., a return 5%. Suppose, that depreciation and maintenance amount to Rs 200 per year. Share Your PPT File, Theories of Interest: Top 6 Theories | Money | Economics. The price level. Conversely, if an economy's saving is higher than its investment, it will cause a recession. 60 B. Everything You Need to Know About Macroeconomics. Only when this ‘overhang’ of debt is reduced will business be prepared to commit substantial funds for new investments. Keynes, therefore, recommended that central banks should follow cheap money policy, i.e., a policy of reducing the rate of interest. one’s speculation partners expectations of profit the price level the initial amount invested Flag this Question Question 5 1 pts Thus, the level of investment is determined at the point where the marginal efficiency of capital is equal to the market rate of interest. Net investment is needed to introduce new products and groups of products or to produce existing products on a much larger scale. Thus with these factors being assumed constant in the short run, Keynesian consumption function considers consumption as a … The most important determinant of an investment's portfolio risk is which of the following? c. the price level. If the expected (estimated) rate of return (profit) on a project were 20% then having to pay 22% interest for investment funds would lead to a loss — the project would not be economically viable. However, post-Keynesian economists … According to John Maynard Keynes, the level of aggregate supply is determined by the level of aggregate demand When we are far below the full-employment leve of GDP, Keynes policy prescription was Investment and changes in consumer demand: the acceleration effect: Another factor influencing the level of investment is the ‘acceleration effect’. In a paper titled "The General Theory of Employment, Interest and Money," Keynes became an outspoken proponent of full employment and government intervention as a way to stop economic recession. British economist John Maynard Keynes is the founder of Keynesian economics. Economics, Investment, Investment and it’s Determinants. The accel­eration effect indicates that the level of aggregate demand is the function of the rate of change of income and product demand. Continuous decreases in spending during a recession result in further decreases in demand, which in turn incites higher unemployment rates, which results in even less spending as the amount of unemployed people increases. He in his book 'General Theory of Employment, Interest and Money' out-rightly rejected the Say's Law of Market that supply creates its own demand. The marginal efficiency of capital is the highest rate of return over cost expected from producing one more unit of a particular type of capital asset. The most important determinant of an investment’s portfolio risk is which of the following? Empirical studies have shown that the capital stock adjustment theory is quite effective in explaining investment levels. 1 shows. The paper will f ocus on testing a question: Which factors impact the size of private investment relative to non -oil economy in the Ceteris paribus, the lower the anticipated rate of interest, the larger will be the number of viable projects and hence the higher the level of total investment under­taken. The portfolio risk of an individual investment is defined as the contribution of the investment to the overall Increase of investment is desirable because it increases income and employment. Investment continues as long as the marginal efficiency of capital is greater than the rate of interest. Keynes believed that unemployment was caused by a lack of expenditures within an economy, which decreased aggregate demand. High and variable inflation is likely to have a damaging effect on investment prospects. At the same time, the profitability of marginal investment — what Keynes calls the marginal efficiency of capital — will also decline as Fig. The rate of interest: ‘the cost of investing’: The main objective of business firms in investing in plant, equipment and machinery is to make profit. Although investment certainly responds to changes in interest rates, changes in other factors appear to play a more important role in driving investment choices. In order to offset this, firms will require higher returns and will be likely to reject otherwise viable investment opportunities. As J.E. According to Keynes, what is the most important determinant of households' spending on goods and services? Deficit spending occurs whenever a government's expenditures exceed its revenues over a fiscal period. investment as a func tion of most important determinants. Investment and capital stock adjustment: If capital-output ratios are flexible firms would be able to obtain more output from a given capital stock. Since Keynes was concerned with short-run consumption function he assumed price level, interest rate, stock of wealth etc. Even though an investment may have high stand-alone risk, portfolio effects often drive its corporate risk to zero. The same thing happens when many businesses find it difficult to collect debts from one another. a. 3. 70 71. If 5% is the highest rate of return which is expected to be secured from any type of investment, the marginal effi­ciency of capital in general in that community at that time is 5%. This will encourage business people to invest more. It explains why the public may hold surplus cash (over and above that demanded due to the other two motives) in the face of interest- earning bonds (and other financial assets). Keynes believed that investment does not depend on the current level of income. ANS: D PTS: 1 DIF: Easy NAT: BUSPROG: Analytic TOP: Introducing Classical Theory and the Keynesian Revolution KEY: Bloom’s: Knowledge 35. Share Your Word File Hence, a high rate of interest will cut out a number of investments and the total volume of investments will be less. 4. With this in mind, Keynesian economics argues that economies are boosted when there is a healthy amount of output driven by sufficient amounts of economic expenditures. 1 decade ago. The most basic principle of Keynesian economics is that if an economy's investment exceeds its savings, it will cause inflation. Fear of loss causes deflation and unemployment and, thus, decreases the volume of investment. c. Autonomous consumption. The consumption function represents the relationship between consumer expenditures and a. interest rates. His mother, one of the first female graduates of Cambridge University, was active in charitable works for less-privileged people. 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