Consumption is the most important component of the total costs of society. Under this concept is understood the costs of the population, which are aimed at the acquisition of goods and services of final consumption. The level of consumer spending is influenced by many factors. One of those is investment. The investment multiplier is a coefficient that shows the change in gross product along with them.
The first multiplier formulas
Keynes linked the explanation of the marginal propensity to consume with the theory of the multiplier. His idea was created by Professor R. Kahn in 1931. He believed that the costs (for example, the organization of public works) become the beginning for the creation of "primary" employment, and also cause the purchasing power of workers and companies that are involved in this activity. They form a new demand, becoming a source of "secondary" employment.
In this case, the new expenses will occupy only a part of the income of the workers or companies, and the remaining funds will be involved to pay debts or postponed. According to Kahn, the multiplier depends on the amount of money spent at each new stage. Thus, an investment multiplier was created, the formula: K = 1 / (1 - K). This idea was developed by Keynes. Its multiplier showed the dependence of national income on attracted investments - (K = DY / DI). It was introduced as a quantity, which depends on an increased propensity to consume. If we consider that Y is national income, I is investment, C is consumption, and a tendency to consume, then the formula will be as follows: DY = DC + DI; DY = ax DY + DI; DC = DY xa; DY = DI (1 - a); DY / DI = 1 / (1 - a) = K> 1 if 0 <a <1; K - investment multiplier.
Investment Multiplier Effect
The increase and decrease in income will be more significant if the changes are caused by investments. This result can be encountered when considering a numerical example. Suppose that initially the investment volume (I0) is 100 (billion rubles), and the consumption function is presented in the following formula: C = 20 + 0.6 x Y. In an ordinary state, the equation has the following form: Y0 = 20 + 0.6Y x 0 + 100. That is, Y0 = 300 (billion rubles).
If the amount of the initial contribution increases to 140 (I1), the equation will be as follows Y1 = 20 + 0.6 x Y1 + 140. Hence, Y1 = 400 (billion rubles). It can be concluded that their growth is 40 billion rubles. led to an increase in income by 100 billion rubles. This phenomenon is called the effect of the investment multiplier.
Investment: investment multiplier
One component of total costs is investment. Most often they are understood as contributions to raising the real capital of society. Most often, they are long-term investments. The extent of their net expenses depends on two main factors. The first is the expected rate of net profit, which should be received by entrepreneurs from expenses. The second factor is the interest rate.
Entrepreneurs producing investment goods will receive more income in the event of an initial increase in investment. When studying indicators, determining the multiplier will be easy.
Expected Net Profit Rate
Profit is the motive for investment costs. That is, the entrepreneur will make purchases only if they are expected to be profitable. You can consider a specific example. The owner of a furniture workshop wants to invest in a new grinding machine. Its cost will be 2000 rubles, and the service life is 1 year. Workshop production should be increased, and, consequently, revenue. It can be assumed that the net expected return is 2500, that is, the investment multiplier is 2.5.
Real interest rate
Another component of expenses is associated with investing. This is the interest rate, that is, the price that the entrepreneur will pay for the loan of funds required to purchase a grinding machine. Investing will become profitable if the interest rate is less than the estimated rate of net profit. It is worth noting that a significant role is played not by the nominal, but by the real interest rate.
Change in national income
By increasing investment, the investment multiplier will show changes in national income per unit. Keynes calculated that this figure is 2.5 for the US and UK economies. The action of one-time investments will continue until the technological innovation that is associated with it is exhausted. For this reason, long-term investments are more profitable. If 0 <D <1, the multiplier will exceed 1, which means that their single increase will lead to an increase in state revenue.
Changes in profits will not be caused by savings, but by investment. Keynes showed how savings are created to achieve the required level of investment. This procedure is performed through multipliers. The scientist attributed all the costs of the entrepreneur to the purchase of equipment to production costs. In this case, it is necessary to calculate the ideal capital efficiency, as well as calculate the profit. The investment structure is of considerable importance in this case. This is due to the fact that the entrepreneur hopes to profit from his capital for a long time.
The rate of interest and its impact on investment
Keynes decides the ratio of profit to salary in favor of the former. A producer can use liquid funds productively if the interest rate is less than the rate of return expected from investments. The scientist defines the rate of interest as a fee made for parting with liquidity. In his opinion, it depends on a subjective assessment of the current and future economic conditions. In this case, investment will become more affordable, as the supply of capital will increase in liquid form.
At the same time, the issue of money will cause prices to rise and lower the increase in liquid assets, as their purchasing power will become less. Demand for money can become limitless at a fairly low interest rate. Keynes denies that the structure of investments can change under the influence of the interest rate, which is also not able to change the investment plans of entrepreneurs in general.
Keynesian school studies investment, the investment multiplier, and also creates practical recommendations. On their basis, social programs were created that received funding from the budget, measures were taken to organize large-scale public works, etc. The investment multiplier allows you to maintain effective demand in the event of a crisis in the economy, and also has a positive effect on the overall economic situation.