Investment Functions (Business Fixed, Residential, Inventory)

1) What is investment in macro?

In macroeconomics, investment (I) refers to expenditure that adds to the economy’s capital stock and inventories. It includes:

1. Business fixed investment (plant, machinery, equipment)
2. Residential investment (housing construction)
3. Inventory investment (change in stocks of goods)

Note: Buying existing shares or existing houses is not “investment” in GDP sense (it’s asset transfer), though brokerage/new construction is.

2) Determinants of business fixed investment

Business fixed investment depends on expected profitability and cost of financing.

Key determinants (CUET-level):

1. Interest rate (r)
   • Higher r increases cost of borrowing and opportunity cost → investment falls.
2. Expected demand / expected sales
   • Higher expected output demand raises expected profits → investment rises.
3. Marginal efficiency of capital (MEC) (Keynesian concept)
   • Investment depends on comparison between expected return on capital and interest rate.
   • Firms invest if expected return ≥ cost of funds.
4. Technology and productivity
5. Business confidence / expectations / uncertainty
6. Tax policy (corporate tax, investment incentives, depreciation allowances)
7. Availability of credit (bank lending conditions, balance-sheet health)
8. Existing capacity utilization
   • If spare capacity is high, firms may delay new investment.

A simple linear form used in models:

where $\bar{I}$ is autonomous investment and $b>0$.

3) Keynesian view: MEC and investment decision (concept)

MEC is the expected rate of return from an additional unit of capital.

Investment rule (conceptually):

• Invest until:

If $r$ falls, more projects become profitable → investment increases.