investment Theory

Investment theory

Definitions: investment is the purchase of a financial product or other item of value with an expectation of favorable future returns.

Investment is an expenditure on new plant and equipment as well as the change in inventories or stock.

Autonomous investment ( I₀ )

·         Autonomous investment is a type of investment where it does not depend on the level of national income; it depends upon others factors. An example of autonomous investment is an expenditure on national security. Even though the level of income increase or decrease, autonomous investment remains the same.

Determinants of investment:

a.             Interest rate

The high interest rate causes the more expensive will it be for firms to finance investment, hence the less profitable will the investment be.

b.            Increased in consumer demand

When national income increase, the demand for goods or services will also increase; the producer will produce more goods and services by installing more machinery and expand their plant size (investments will increase).

c.             The cost and efficiency of capital equipment.

If the cost of capital equipment goes down or machines become more efficient, the return on investment will increase. Firms will invest more. Technological progress is an important determinant here.

d.            Expectations

Since investment is made in order to produce output for the future, investment must depend on firms’ expectation about future market conditions. Example; if the expected future dividend for ASB will increase, so investor in ASB will increase their investment by today. It because to get more profit at the future.

e.             Business taxes.

An increase in business taxes will lower the profitability therefore investment will decrease.

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Saving Theory

Saving Theory

Definition: Saving is the conservation of money. Methods of saving include putting money aside in a bank or pension plan. Saving also includes reducing expenditures. Saving includes buying securities and deposits money with financial institutions.

 

Saving function: S = -a + (1 – b)Yd

 

S = Saving

a = autonomous consumption

1 - b = MPS

Yd = disposable income

            Average propensity to saving (APS)

The average propensity to save (APS), also known as the savings ratio, is an economics term that refers to the proportion of income which is saved, usually expressed for household savings as a percentage of total household disposable income.

Formula:        APS = Saving (S) / income (Y)

Marginal propensity to saving (MPS)

·         Marginal propensity to saving (MPS) is the relationship between a change in income and corresponding change in saving.

Formula:        MPS = Change of saving (∆S) / Change of income (∆Y)

                            

Determinants of saving

a.Disposable income (Yd)

              

                As disposable income (Yd) increase, saving will reduce but when income (Y) rises,

                saving also will increase.

b.Wealth

                

                 Wealth means real assets and financial assets which household own. The greater

                 amount of wealth will increasing total of saving.

c.Expectations

               

                Household expectation concerning future prices and availability of goods may have

                  a significant impact on current spending and saving. If individuals expected the

                  general price will increase in the future, they will reserve their money by today

                  (increase saving). 

d.Availability of financial institutions

The more banks and finance companies that exists, the more opportunity

   individuals have to save.

e.Psychological reasons/ habits and customs

   It might be habitual for some to put aside a certain amount a month for a rainy day.

   Some people save more due to habits or customs.

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Consumption Theory

Consumption Theory

Definition of consumption:

·         Measurement on household spending on goods and services.

·         Consumption function shows relationship between consumption of households by disposable income an economy. 

C = a + bYd

Consumption function; => C= a + bYd

                                   

C = consumption

a = autonomous consumption

b = MPC

Yd = disposable income

Law of consumption; when income low, their consumption also low but when income high, consumption also high. Therefore, law of consumption has positive relationship.

Autonomous consumption

·    The minimum level of consumption that would still exist even if a consumer had absolutely no income.

Average propensity to consume (APC)

·         Average propensity to consume (APC) is the percentage of income spent. To find the percentage of income spent, we need to divide consumption by income

Formula:        APC = consumption (C )/ income(Y)

    Marginal propensity to consume (MPC)

·         Marginal propensity to consume is the relationship between a change in income and corresponding change in consumption.

Formula:        MPC = Change of consumption (∆C) / change of income (∆Y)

Determinants of consumptions

a.             Disposable income (Yd) @ income (Y)

In general, household consumption is depending in their disposable income. If disposable incomes increase, household consumption will increase too. This disposable income counted after tax deduction.

                       

b.            Interest rate and Loan Condition

When interest rate in the market was decrease, borrowing cost would become cheaper. As such, consumption spending in country would be higher. Consumption spending will also increase if loan condition charged by banks very loose.  So, the consumer easy to get the loan and it will increase the total consumptions.

c.             Government policies

Through fiscal policy, if governments reduce tax its will reduce commodity prices. So, the disposable income will increase and these further encourage total consumption. 

                                   

d.            Hire Purchase and Credit Facilities

If easy for someone to get debt facility, it can increase consumption. In this concept, society use concept “buys now and pays later". Example; credit card.

e.             The invention of new goods

The invention of new goods was coming into market to replace old commodities. For example color TV replacing black and white TV, the level of consumption is expected to rise.

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Concepts equilibrium of National Income

Concepts equilibrium of National Income

In the simple Keynesian Theory, the concepts of equilibrium is achieved when aggregate demand (AD) equal to aggregate supply (AS). 

There are three main sectors in economy;

·                     2 sectors economy

·                     3 sectors economy

·                     4 sectors economy

There are two methods of determination of national income

                                             i.                        Aggregate Demand = Aggregate Supply

                                           ii.                        Injection = Withdrawal @ leakages

 2 sectors economy

The components in 2 sectors economy are household and firm.

                                            i.            Aggregate Demand = Aggregate Supply

Aggregate Demand = consumption (C ) and investment (I)

Aggregate Supply = income (Y)

      AD = AS

      C + I = Y

 

                                            ii.            Injection = withdrawal @ leakages

Injection = Investment (I)

Leakages = Saving (S)

                            Injection      =     leakages

                           I       =     S

3 sectors and 4 sectors will be update later..

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Aggregate Demand (AD) and Aggregate Supply (AS)

Aggregate demand (AD) and aggregate supply (AS)

Aggregate demand (AD) and aggregate supply (AS) analysis provide a way of illustrating macroeconomic relationships and the effects of government policy changes.

Aggregate Demand

Aggregate demand is the total demand for final goods and services in the economy (Y) at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels.

Aggregate Supply

Aggregate supply is the total supply of goods and services produced by a national economy during a specific time period. It is the total amount of goods and services in the economy available at all possible price levels.

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Method of measuring National Income

Method of measuring national income

           

We need information on how much is our spending, income and output had been created in an economy over a period of time.

Measuring national income

There are three ways to measure the National Income:

a.       Income method

b.      Output method

c.       Expenditure method

What is National Income?

National income measure the money value of the flow of output in form of goods and services produced within an economy over a period of time. Measuring the level and rate of growth of national income (Y) is important to economists when they are considering:

·                     Economic growth

·                     Standards of living

·                     Distribution of income

a.         Income method

Here GDP is the sum of the incomes earned through the production of goods and services. The main income of factors are as follows:

·                     Wages and salaries

·                     Interest and dividends

·                     Rent

·                     Profit

·                     Income from employment and in self-employment.

It is important to recognize that only those incomes that are actually generated through the production of output included in the calculation of GDP by the income approach.

The following items are excluded from the accounts:

·                     Transfer payments e.g. the state pension payment for retirement; income support paid to families on low incomes; the Jobseekers’ Allowance given to the unemployed and other forms of welfare assistance including child benefit and housing benefit.

·                     Private transfers of money from one individual to another.

·                     Income that is not registered. Every year, billions of RM worth of economic activity is not declared to the tax authorities. This is known as the shadow economy where goods and services are exchanged but the value of these transactions is hidden from the authorities and therefore does not show up in the official statistics!). It is impossible to be precise about the size of the shadow economy but some economists believe that between 8 – 15 percent of national output and spending goes unrecorded by the official figures.

b.           Output method

To measure national income based on product method are predicated to help each sector in country. These sectors can be classified into three; primary sectors, secondary sectors and tertiary sectors.

                                                         i.            The primary sectors

-          Agriculture, forestry, and fishery.

-          Mining and quarry.

                                                       ii.            The secondary sectors

-          Manufacturing/ industry

-          Construction

                                                     iii.            The tertiary sectors

-          Electric, gas and water.

-          Transport, storage and communication.

-          Wholesale trade and retail, hotel and restaurant.

-          Finance, insurance, estate and property business service.

-          Government service.

-          Other services.

 

c.         Expenditure methods

There are three components in calculating national income by using expenditure methods.

                                                         i.            Household expenditure and consumption

                                                       ii.            Producer expenditure or gross investment or gross private capital expenditure

-          Example; new construction such as housing, factories, equipments like machinery tools, changes in business stocks or inventories.

                                                       iii.            Government expenditure on goods and services excluding transfer payments.

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