Investment & Investment Multiplier

INVESTMENT FUNCTION
Implies real invt- addition to existing stock of real capital assets
(construction of new offices, new factories, building of P & M,
equipments) & addition to inventories

ESTIMATING PROFITABILITY OF INVT PROJECTSNET PRESENT VALUE OF CAPITAL ASSET

Suppose a manager can purchase a stream of future receipts (FVt )

by spending C0 rupees today. The NPV of such a decision is:

FV1
FV2
FVn
NPV C0
1
2 ...
n
1 i 1 i
1 i
NPV < 0: Reject
NPV > 0: Accept

EXAMPLE
An investment costs Rs 100 lakhs this year and is expected to
yield net returns of Rs 30 lakhs, 40 lakhs & 60 lakhs in the next
three years respectively. Assuming that the interest cost of
money is 10%, calculate the Net Present Value.

30
(1 + .1)

40
(1 +

.1)2

= Rs 6.51 lakhs
Investment is desirable

60

(1 + .1)3

100

EXAMPLE
A machine having an economic life of 5 years yields Rs 1000
every year. Its present cost is Rs 3500 & rate of interest is 12%.
Is it profitable to invest in this machine?

Calculate P.V. (Rs 3604)

Since P.V. > Cost, profitable

MULTIPLIER (k)

Ratio of final change in NY to the initial change in

planned expenditure (I, G, X) that stimulated it

A given change in I will be associated with a

change in Y larger than itself

It tells how an economy moves from one level of Y

to another level as a result of shifts in AD schedule

TWO SECTOR MODEL

Ratio of final change in NY to the initial change

in investment that stimulated it
K = final change in Y
initial change in Y

K = Y
I

STATIC MULTIPLIER: CONCEPT

K = ____1_____
1 MPC

Greater the value of MPC, greater is multiplier

When MPC = 0 then k = 1

When MPC = 1 then k =

K lies b/w 1 &

(Derivation)

STATIC MULTIPLIER: DIAGRAMMATIC

PRESENTATION
Y

C + I + I
F

AGGREGATE
PLANNED
EXP,
CONS
INVT

C+I
M
E

Y1

Y2

AGGREGATE REAL INCOME

STATIC MULTIPLIER : EXAMPLE

MPC

MPS

0.2

0.8

1.25

0.33

0.67

1.5

0.4

0.6

1.67

0.5

0.5

0.6

0.4

2.5

0.8

0.2

0.9

0.1

10

DYNAMIC MULTIPLIER: CONCEPT

Takes into account time factor

Explains the process by which O/P adjusts itself to

new level of demand

DYNAMIC MULTIPLIER: PROCESS OF INCOME

PROPOGATION

C = 20 + 0.5 Y

I = Rs 20 Crore

So, Original level of income, Y = Rs 80 crore

CONTD.

DYNAMIC MULTIPLIER: PROCESS OF INCOME

PROPOGATION
PERIOD

80

20

20

100

20

10

30

110

20

10 + 5

35

115

20

10 + 5 + 2.5

37.5

117.5

20

10 + 5 + 2.5 + 1.25

38.75

118.75

20

20

40

120

DYNAMIC MULTIPLIER: DIAGRAMMATIC

Y =PRESENTATION
C+S
Y

AGGREGATE
PLANNED EXP,
CONS, INVT

C + I + I
F

C+I
M

Y1

Y2

AGGREGATE REAL INCOME

MANAGERIAL IMPLICATIONS

Manager should be able to foresee the effect of rising/

declining I in economy on Y

Revision of production & marketing plans to tap

additional consumer Y

APPLICABILITY OF MULTIPLIER THEORY TO

LDCS

Refer the handout