Question

Please describe the concept of investment spending, as well as what will happen to the aggregate demand curve if investment spending is increased autonomously. Also provide an example of spending that a macroeconomist would consider “investment spending.”

Answer 1

Investment spending refers to spending done by the government and/or private sector in order to increase the capital assets in the economy. They are injections into the circular flow of income.

The main determinants of investment are:

(i) Expected return on investment

(ii) Business confidence

(iii) interest rate; etc.

The Investment spending function is given by the following fomula:

I = Io - bi

where Io = autonomous spending, b = responsiiveness of investment to interest and i = interest rate

Investment spending (I) is a component of the aggregate demand in the economy. It is given by:

Y = C + I + G + NX

where Y = Aggregate demand/ output

C = consumption spending

I = Investment spending

G = government spending

NX = net exports

An increase in autonomous investment, Io, will lead to an equivalent increase in Aggregate demand, thus shifting the aggregate demand curve to the right by the amount Io.

For example. Purchase of machinery, land, production inputs etc.