LEGAL CLAIM: Ownership of the physical goods, services, and resources that make up the real side of the economy. Legal claims are a key feature of the paper, or financial side of the economy. Transferring legal claims is the primary method of diverting income from household saving to investment and government borrowing. Legal-claim buyers loan income and legal-claim sellers borrower income.
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Business investment expenditures that depend on income or production (especially national income and gross domestic product). That is, changes in income induce changes in investment. Induced investment reflects the observation that the business sector is inclined to reinvest profits (boosted by a growing economy) in capital goods. It is measured by the marginal propensity to invest (MPI) and is reflected by the positive slope of investment line. The alternative to induced investment is autonomous investment, which does not depend on income. Induced investment is investment expenditures by the business sector that are based on the level of income or production. This is one of two basic classifications of investment. The other is autonomous investment, investment expenditures that are NOT based on the level income or production. In other words, business investment can be divided into: (1) expenditures which are undertaken by the business sector regardless of the level of aggregate production and (2) an adjustment of expenditures (more or less) that results because aggregate production and income changes.
Investment expenditures are commonly assumed to be totally autonomous in the introductory analysis of Keynesian economics. That is, any induced investment that realistically exists is ignored. Doing so not only simplifies the analysis, but also places the focus on how and why autonomous investment changes, and how such changes affect the macroeconomy. More sophisticated, and realistic, analysis then includes induced investment.
Investment expenditures are induced because business firms are prone to use profits generated by a growing, expending economy to finance capital investment. If business is good, production is up, and revenue is increasing, then so too are profits. This makes it easy for business firms to finance capital investment. As such, investment expenditures are induced by the increase in aggregate income and production. While induced investment is not nearly as big or important as induced consumption, it does play a key role in Keynesian economics. It affects the determination of equilibrium and the magnitude of the multiplier process.
Induced investment is reflected by the slope of the investment line and the marginal propensity to invest (MPI). The MPI is important to the slope of the aggregate expenditures line',500,400)">aggregate expenditures line which also affects the value of the expenditures multiplier.
Induced: An EquationOne way to illustrate induced investment is with a linear investment equation, such as the equation presented here:where: I is investment expenditures, Y is income (national or disposable), e is the intercept, and f is the slope.
As with any linear equation, the two key parameters that characterize this investment equation are slope and intercept. Induced investment is indicated by the slope of the investment equation. Autonomous investment is indicated by the intercept.
- An Induced Slope: The slope of the investment equation (f) measures the change in investment resulting from a change in income. If income changes by $1, then investment changes by $f. This slope is generally assumed and empirically documented to be greater than zero, but less than one (0 < f < 1). It is conceptually identified as induced investment and is measured as the marginal propensity to invest (MPI).
- An Autonomous Intercept: The intercept of the investment equation (e) measures the amount of investment undertaken if income is zero. If income is zero, then investment is $e. The intercept is generally assumed and empirically documented to be positive (0 < e). It is conceptually identified as autonomous investment.
Induced: A Line
Another common way to identify induced investment is with an investment line, such as the one presented in the exhibit to the right. The red line, labeled I in the exhibit, indicates investment that is completely autonomous. There is no induced investment indicated by this line. As such, the slope of the investment line is zero (f = 0). The intercept of this horizontal line indicates autonomous investment, which is $2 trillion in this exhibit.
However, investment is realistically induced by the level of income and production in the economy. An induced investment line has a positive slope. And because investment expenditures are only modestly induced by income and production, an induced investment line has a slight slope. A click of the [Induced A Little] button illustrates induced investment (with a comparison to the autonomous investment line).
The new red line, labeled I' in the exhibit, is the positively-sloped investment line for the equation: I = 2 + 0.10Y. This line indicates that greater levels of income generate greater investment expenditures by the business sector.
The two primary characteristics of this investment line--slope and intercept--indicate the difference between autonomous investment and induced investment.
- An Induced Slope: The slope of this new investment line is positive, but less than one. In this case the slope is equal to 0.10, a $1 change in aggregate production induces a $0.10 change in investment expenditures. This positive slope indicates induced investment. Moreover, the slope of the line is also the marginal propensity to invest (MPI).
- An Autonomous Intercept: This new investment line, like the original line, intersects the vertical axis at a positive value of $2 trillion. And once again this indicates autonomous investment.
Other Induced ExpendituresInvestment is one of several induced expenditures. The other three aggregate expenditures--consumption expenditures, government purchases, and net exports--are also induced by income and production.
Other components of the macroeconomy are also related to, or induced by, income and production. An important one is saving, which is the other side of consumer behavior. Consumption and saving are both induced by income. The psychological law states that an increase in income is used both for extra consumption and extra saving. A second induced part of the macroeconomy is taxes. In particular, sales and income taxes are directly related to income. More income invariably means more taxes. Another is the demand for money. Because expenditures use money, an increase in income not only induces expenditures, it also induces the demand for money.
- Consumption is unquestionably the most important induced expenditure. It is not only the largest of the four aggregate expenditures, but it is also the most induced of the four. It captures the fundamental psychological law and triggers the largest change in expenditures resulting from a change in income or production.
- Government purchases are induced by income and production because extra income generates more tax revenue (especially state and local tax revenue), which is then used by government to finance expenditures.
- Net exports, the difference between exports and imports, are induced through imports, which are induced in the same fashion as investment expenditures. An increase in income is not just used to purchase domestic goods, but also imported goods.
INDUCED INVESTMENT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 24, 2024].
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