Introduction Theoretical Theories Of Investment Economics Essay

Introduction Theoretical Theories Of investing Economics Essay investing is a st rangegic variable in the determination of the level and outgrowth of income. It has been specify in various ways by various economists. Gener altogethery, it refers to every act of spending with a prospective yield. To the economist, it refers precisely to the process of bang-up formation whereby thither is net addition to the existing assets including inventories and goods in the phone line of production. It is the actual production of keen equipment, tools and another(prenominal) produced means of production. investiture aptitude be large(p) of the United States formation Financial Capital and Physical or au sotic detonator. in that location atomic number 18 gross, net and autonomous enthronizations where rude coronation= Net Investment + Autonomous InvestmentAutonomous Investment overly known as Government Investment refers to investiture which remains the alike(p) whatever the lev el of income. It refers mainly to the investing made on houses, roads, semipublic buildings and other parts of Infrastructure made by the government.Moreover make investment is the hail that a comp whatsoever has invested on an asset or business without taking factoring in depreciation into carryation. In other words it is the positive amount of currency spent for the creation of fresh capital assets like Plant and Machinery, Factory Building etc. It is the total expenditure made on new capital assets in a period of time.Further more(prenominal) in economics, Net Investment refers to an activity of spending which pass on cause an increase in the availability of fixed capital goods or means of production. It is the total spending on new fixed investment minus heterotaxy investment, which simply replaces depreciated capital goods. In fact it is Gross investment slight Capital Consumption during a period of snip. snobby Investment counts on various categories of variables. So various theories of investment acquit been usher ined and they are provided overleaf-fisher supposition of InvestmentThis possibleness was actual in 1930. Fishers speculation was originally create as a hypothesis of capital, but as he assumes that all capital is circulating, then it is fair(a) 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, much(prenominal) that a stock of capital K did not exist. In fact all capital is practiced investment.There was a condition imposed by Fisher stating that Investment in any given period of time allow for yield railroad sidings in the nest period. This is illust commitd through the equation infraY2=F N,I1Y2 = Output in period 2I1 = Investment through in period 1N = laborAssuming 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 poss ibilityThe Keynesian theory was positive after that John Maynard Keynes (1936) followed suit of the Fisher theory. Keynes stated that there is an autarkic investment function in the economy. An important aspect of the Keynesian theory is that although savings and investment must be identical, ex-post savings and investment decisions are made by different decision makers and there is reason wherefore ex-ante savings should equal ex-ante investment. correspond to Trygve Haavelmo (1960) The Keynesian burn down places far less emphasis on the allowance account temper 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 organism an important social f unction that needs to be optimumly decided heavy weapon Principle TheoryOver the past two decades, the acceleration principle has played a vital role in the theory of 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 bum of the accelerator principle is based on the fact that changes in factors bear upon national income would affect investment. In other words, big percentages changes are witnessed collect to small in consumer spending. This type of investment is known as induce investment since it is induced by changes in consumption and income. Furthermore, the accelerator is just the numerical take account of the relationship amid the increases in investment caused by an increase in income. Normally, it lead be po sitive when national income increases. On the other hand, it might accrue to zero if the national output or income remains costant.Neo-Classical TheoryIn 1971, the neo true approach which is a stochastic variable of the flexible accelerator ideal was formulated by Jorgenson and others. Flexible Accelerator Model is a more general form of the accelerator model. It is off-key that firms ordain choose only a fraction, a, of the gap amid craved and current actual level of capital stock each period. The larger the gap between the desired capital stock and the actual capital stock, the greater a firms station of investment. This is illust charge per unitd 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 numbers on the price of capital goods, the real send of liaison, the rate of depreciation and the tax structure. It is important to follow that most recent empirical works are based on Jorgenson investment function. In fact Jorgenson provides that a decrease in occupy rate would cause an increase in investment by reduce 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, use up rates. In fact Hall and Jorgenson had used the neoclassical theory of optimal capital accumulation to analyze the relationship between tax insurance 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 great deal be defined as the ratio of the market value of the existing capital to the replacement cost of capital. Q can be defined as followsQ=Stock tax of Firm/Replacement cost of InvestmentQ is a barometer for investors as it tends to evaluate a firms prospect. When Q is greater than one, the firm would make additional investment because the gain generated would be greater than the cost of firms assets. If Q is less than one, the firm would be give away 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 virtually equal to one denoting that the firm is in equilibrium.The Q theory of investment can also depend on adjustment cost. Literature on this make love was done by Eisner and Strotz (1963), Lucas (1967), Gould (19678) and Tredway (1969). Late r Mussa (1977), Abel (1979, 1982) and Yoshikawa (1980) showed that Investment is an increasing function of the tincture price of installed capital. This is such only when there are broken-backed adjustment cost.Marginal Q Model of InvestmentMoreover Abel (1981) and Hayaski (1982) introduced the marginal q model associated with debonnaire convexo-concave 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 fire 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 honest of all prices. Hayask i (1982) provides that under linear homogeneity, marginal q is equal to average q. so far 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 stochastic 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 speculate 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 acces s the market like capital gains taxes, price public press etc. The model used by Panageas also aid to divulge between rational and behavioural theories of asset pricing anomalies.Models associated with non-convex costsThere are also models with Non-convex costs of adjustments. King and 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 mortalfirms in response to shocks. These non- convex costs is linked with the investment theory. A number of influential partial tone 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 study following large aggregate shocks.Theories of Interest markThere is a vast spectrum of saki rate at a given period of time in a country. The interest group rate will depend o n several variables such as nature of loans, duration of loans, realization worthiness of borrower, hire purchase agreements. When those variables are held constant, the rate of interest or pure interest rate is obtained. The most common theories used to inform interest rate determinations are the Loanable pecuniary resource Theory (Neo Classical) and the Liquidity resource 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 funds 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 strike and provide of loans in the credit market. The hold for loan is mainly to invest, to consume and to hoard. Traditionally the demand curve will slope downward because a fall in interest rate will attract borrowings. The write out of loans comes from 4 important sources. These are saving, verify silver, 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 to the Loanable funds theory, the rate of interest will be determined where these two curves meet. This is shown belowRate of interestSLR1Q1DL sign 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, expert 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.Liquidity Preference Theory/Keynesian TheoryThe Liquidity Preference Theory was d eveloped by Keynes. Keynes described interest rate as a purely pecuniary phenomenon which is determined by the demand and supply of gold. 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. preventative 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.big demand for moneySpeculative demand is th e demand to hold money as oppose to the holding of bonds. There is an inverse 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 offense 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 ascertain 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 will 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 front 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 enrolment 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.