Planned Investment is defined as planned spending devoted toward increasing or maintaining the stock of capital. Planned Investment, as defined here, does not include planned buying of bond, purchasing of stocks, creating deposits in banks, etc. There are three kinds of investment:
i. Housing construction (residential and business);
ii. Purchasing of machinery; and
iii. Additions to a firm’s inventory of goods.
For the sake of simplicity, we will assume that investment, as used here, is autonomous, meaning it does not depend on aggregate income. There are two main determinants of such investments:
- Anticipated Rate of Return: Businesses invest because of profit. This implies that investment spending is based on profit motive; the business sector buys capital goods only when it anticipates such purchases to be profitable.
- The real interest rate (i): Business firms, at times, borrow funds for investment. These borrowed funds are repaid out of future revenues. The annual opportunity cost of using a Naira to make an investment is represented by the real interest rate. Thus, the higher the real rate of interest, the less will be the profits to the business after paying interest and the less it will want to invest and vice versa.
Fig. 11.4a: Autonomous Investment Fig. 11.4b: Investment Function
Figure 11.4a shows the level of autonomous investment spending which remains constant at A irrespective of income levels. It is an investment spending which is independent of income changes.
Fig. 11.4b shows that investment expenditure (I) increases as interest rate (i) falls from i1 to i2. An investment demand curve shows the relationship between gross investment and the rate of interest, holding constant other variables that affect investment spending.