If an economy experiences a reduction in overall consumption, do we expect firms’ investment to increase...

If an economy experiences a reduction in overall consumption, do we expect firms’ investment to increase or decrease? Explain your answer.

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Expert Solution

Among the determinants of aggregate, the top most one is the level of consumption spending. There is a perfect correlation between the induced investment (private investment) and the consumer spending. Every businessman while investing, calculate the expected return or marginal efficiency of capital from every additional investment. The business return is directly depends upon the sales of business firms. During times of higher sales due to increased consumption spending, the return on investment is higher and the business firms are committed to undertake more and more additional investment. On the other hand during times of fall in sales the return on investment will be low so that the firms try to reducing investment to the maximum. Thus the overall investment falls during times of decreasing consumption.

The firm's investment is expected to decrease during times of reduction in overall consumption.

Rahul Sunny answered 1 year ago

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