Question

Write a short note on theories of investment.

Answer 1

Theories of Investment explain the determinants and behavior of investment in an economy. Broadly, there are two main types of investment theories:

1. Induced investment theory: Investment is induced by the profit motive and depends on the expected rate of return. Entrepreneurs decide to invest when the expected marginal efficiency of capital (MEC), which is the anticipated rate of return on investment, exceeds the cost of borrowing, often the rate of interest. Investment increases when MEC exceeds the rate of interest and falls when it is less. Thus, investment is responsive or “induced” by income and profit expectations. This theory is associated with Keynes and post-Keynesian economists who emphasize the marginal efficiency of capital more than interest rates.
2. Autonomous investment theory: This type of investment occurs independently of current income or profits. Autonomous investment, often public investment, is driven by factors such as technological innovation, development of resources, or government policy aimed at achieving long-term growth objectives. It is considered income-inelastic and is essential during periods of economic downturn to sustain employment and growth.