THE INVESTEMENT

FUNCTION

INVESTMENT

Is one of the components of aggregateExpenditure.

It is a balancing factor.

SOURCES AND USES OF INVESTMENT FUNDS

TWO SOURCES:a. Public sectorb. Private sector

RESULT:a. Savingsb. Borrowings

INVESTMENTS ARE UNDERTAKENTHE FF:a. Governmentb. Business firmsc. Private individuals

Private personsBusiness firmsGovernment

FinancialInstitutions/

Foreign Countries

Investment Funds

Savings Borrowings

ConstructionsMachinery

and Equipment

Public Works

Figure 44

SOURCES AND USES OF

INVESTMENTS FUNDS

ROLE OF INVESTMENT1. Investment constitutes a major portion of aggregate demand

2. Investment paves the way for increasing the nation’s output as well as promoting longrun economic growth.

P 30 million forwages laborers

Food clothing Tuition

recreation

companies

P 70 million formaterials and

supplies

companies

WagesMaterialsSupplies

Figure 45

THE ECONOMIC EFFECTS

OF INVESTMENT

InvestmentSpending

- New buildings-New equipment-Manpower training

IncreasedCapacity ofBusiness firms

Higher level of employment of

resources

BiggerPotential

Output and aggregate supply

Figure 46

INVESTMENT,POTENTIAL OUTPUT

ANDECONOMIC GROWTH

INVESTMENT AND THEMULTIPLIER EFFECT

The ratio of a change in income to a change Investment is called the MULTIPLIER

K =Change in Y

Change in I

WhereK = multiplierY = incomeI = investment

K =1

1 - MPC

WhereK = multiplierMPC = Marginal

Prosperity to Consume

Construction Project

P 100 million

Workers

Suppliers

WorkersWorkers

Suppliers

SuppliersSuppliers

labor

Wages payments P30 million

PaymentsP30 millionmaterials

and supplies

Paymentsof P70 million

FoodClothing

Educationrecreation

Wages payments P10 million

labor

materials and

supplies

PaymentsP20 million

PaymentsP60 million

labor

Wages payments P10 million

materials and

supplies

Figure 47

THE MULTIPLIER EFFECT OF

INVESMENT

TYPE OF INVESTMENTTANGILABLE CAPITAL

structures equipment inventories

INTANGIBLE INVESTMENT “human capital” research and development health

INVESTMENT MAY ALSO BE:

GROSS INVESTMENTIs investment without allowance fordepreciation.

NET INVESTMENTIs the gross expenditure on capital formation minus the amount required to replace worn-out and obsolete plant and equipment.

THE DETERMINANTS OF INVESTMENT

1. INTEREST RATEWhen interest rates are high,

investments tend to be low. RIO (Return On Investment)

2. INNOVATIONSRefers to the introduction of new

Products or production processes.

3. PROFIT When costs are high and revenues

are low, profits will also be low.

4. EXPECTATIONSWhen a particular segment of the marketIs unserved or undeserved, the managementOf a concerned business firms may decideIn favor of investment.

Table 32

EXPECTATIONS AND INVESTMENT SCHEDULE

Interest Rate(in percent per year)

Investments(in billions of pesos)

WorseExpectations

Current Trend

Better Expectations

2468101214161820

700500375310260225180150125100

800600475410360325280250225200

900700575510460425380350325300

REAL AND NOMINAL INTEREST RATES

To compute for the real rate of interest, the expected inflation rate is deducted from the nominal rate. The interest rate that is actually paid and received in the marketplace is referred to as the NOMINAL RATE OF INTEREST.

Table 33

INTEREST RATES, INFLATION AND INVESTMENT

Year(A)

InterestRate (B)

(in percent)

InflationRate (C)

(in percent)

Real InterestRate (B-C)

(in percent)

Investment(in billion

Pesos)

19971998199920002001

678910

68101214

0-1-2-3-4

8009001,0001,1001,200