It is impossible to talk about finance, entrepreneurship, business, and at the same time not to mention some essential terms. For example, to build the correct economic formulas, it is necessary to understand what investment functions exist, how they work and what role they play for the development of the entire industry.
The essence, types and examples
In the well-known Keynesian theory, investments and, above all, investment expenditures are an integral part of the total expenditures of the population along with government procurement and net export of goods and services. Economists consider it the most volatile and dynamic component due to its dependence on many factors. If we look more deeply at investments (functions, types, their significance, methods of application), then we will have to go a little beyond the scope of this theory.
What is understood in the broad sense of investment?
Investigation of the concept of investment is devoted to the scientific works of the classical, Keynesian, marginalist Marxist and other schools. Let us dwell on three definitions.
Investments (in the broadest sense) are capital investments in economic sectors, the scientific and technical sector, infrastructure, social and environmental measures, in the development of production and entrepreneurship.
Narrow investment
From the point of view of finance, the investment functions are reduced to the investment of funds (assets) that are used in the process of production and economic activity.
The economy interprets investments as expenses of entities for the purpose of capital accumulation, which provide for the creation of new capital and the reimbursement of depreciated funds. On this side, the main function of investments is to generate income. In other words, the subjects of the national economy invest part of their income in the development of the economy so that it pays off and returns to them in an increased amount.
Entrepreneurs also consider the investment as a business transaction for the acquisition of production and non-production funds and financial instruments in exchange for property or cash. At the same time, investment expenses can contribute to an increase in capital or maintain it at the previous sufficient level.
And although the share of investment expenditures in total national expenditures is one fifth, fluctuations in business activity and the positive growth of the economy depend on them — ceteris paribus, increased investment will proportionally increase gross domestic product.
Investment Functions in the Economy
From the definitions of investments, it can be seen that these processes can be carried out both at the state and private levels of an economic entity, but ultimately it comes down to increasing the welfare of the state. This means that the functions performed by investments are designed to satisfy all interested parties: households, banks, enterprises, formal and informal institutions, associations, the public sector. We highlight four key properties that make investment the cornerstone of macroeconomics:
- The distribution function is interpreted as follows: choosing where to invest money or assets, the entrepreneur or the state contributes to the development of one industry more than the other. As an example, it looks as follows: domestic can’t compete with foreign electronics and cars, it is more profitable for an entrepreneur to invest money in something else.
- Regulatory property: investments are made globally and affect related sectors of the economy. The new plant involves laying roads, a recreation center, creating new jobs, etc.
- Stimulating: investing involves investing in improvement. Science, technology, level of education are being optimized, and as a result, the quality of life and well-being of the country are improving.
- Indicative: an investment property that is closely related to capital growth processes and maintaining the balance of an open economic system.
Having examined the theoretical aspects of the formation and functioning of investments, let us move on to their graphical display, which clearly shows how the consumption function, investment function , savings and consumption are interconnected on a national economic system scale.
Definition
Any function, mathematical or economic, is the dependence of the final result on one or many factors. Investment functions are also models in which the endogenous variable (end result) is investment expenditure, and the exogenous is determined by the objectives of the study.
If there is one independent variable, then they speak of others "under other given conditions." So, if investments are specified by a function of income, this means that the bank interest rate and prices have not changed significantly in this period.
The more independent variables, the higher the reliability of the model and its proximity to the real conditions of the economy. The dynamics of the variables can vary greatly in different periods, and to simplify the task, researchers choose one or two main factors on which the investment functions will depend.
The relationship of investment and interest rate
It is no exaggeration to say that the size of investments depends on the interest rate, while the change in other factors is taken over by the autonomous investment function included in the multifactor model, which has the following form:
- I = Ia - d * r (1), where
I - total investment costs;
Ia - autonomous investment expenses;
d - investment sensitivity to decrease or increase in the rate,%;
r is the real interest rate.
The interest rate value is explained quite simply. Every businessman, before investing in a risky enterprise (and 100% risk-free investments do not exist in principle), estimates how much he can earn on it and how much you need to spend for this. For large-scale investments, domestic financial resources are often not enough, and the entrepreneur is sent to a bank or non-banking financial institution, which requires a price for its services - the same percentage. The higher the price of the bank, the lower the profit of the businessman and the ratio of profit to cost. As you know, maximizing profits from all activities is the ultimate goal of any enterprise.
Other examples
You need to understand that there are a huge number of ways to use such an instrument as investment. The income function, for example, is built taking into account a given financial transaction. In addition to loans and non-bank loans for the purchase of equipment, machinery or financial instruments, an entrepreneur can spend money from his pocket. At the enterprise, this is part of the profit that remains after payment of taxes and other planned deductions. In this case, fluctuations in the final amount of investment expenses will directly depend on the change in the function of the operating income of the enterprise. Profit is growing and its part consumed - investments are increasing. Losses increase - investment is reduced or minimized indefinitely. Then the investment function has a form that differs significantly from the previous example, since we add total income.
The marginal propensity to invest is a multiplier that shows how much investment will increase or decrease when the unit of income changes. The higher the value of the multiplier, the more the entrepreneur is prone to risk. If you win, investments can return in multiple sizes, and if you lose, they can lead to huge losses and even bankruptcy.
Consumption and investment
All incomes of economic entities are distributed in two funds: consumed and accumulated. The accumulated part, in other words, savings, is the profit that remains inside the company and remains inactive for some time. Consumption is used to pay taxes, obligations, salaries to employees and other purposes.
Investing and risk
Investments are consumed and returned to enterprises in the form of equipment and assets, which means that it is important for the entrepreneur that the capitalized part of the profit is as low as possible. On the other hand, if the investment in the reporting period was not very successful and did not provide an inflow of money, the enterprise is forced to resort to external sources of financing. Again, these are banks, financial institutions, formal and informal financial markets. And again the question arises: take risks or not take risks?
The optimal structure of the distribution of income (profit)
Perhaps one of the questions that neither practice, nor theorists can give a definite answer: where is the equilibrium point for investment and accumulation? Even within the framework of one enterprise it is impossible to say unequivocally that it is better to accumulate or consume, because market conditions, technologies, socio-legal and political sectors are constantly changing. That tomorrow would bring enormous losses, yesterday threatened with bankruptcy, and vice versa.
Mathematically, the investment functions do not provide a universal solution - they only reflect averaged trends, discarding a number of insignificant factors that can suddenly become significant. For the leader, they serve as a generalized example, and the final decision on investing is made after a thorough study of all factors and the real situation in the economy.