Revision: Consumption and Investment Functions Economics HSC Arts Class 12 Tamil Nadu Board of Secondary Education

• "Investment refers to the increment of capital equipment." — J.M. Keynes
• "By investment we do not mean the purchase of existing paper securities, bonds, debentures or equities, but the purchase of new factories, machines and the like". — Stonier and Hague
• "Investment expenditure includes expenditure for producer’s durable equipment, new construction and the change in inventories." — Peterson

• The multiplier is defined as the ratio of the change in national income to the change in investment.
• If AI stands for increase in investment and AY stands for resultant increase in income, the multiplier K = `"AY"/"AI"`.
• Since AY results from AI, the multiplier is called investment multiplier.

According to Keynes, “Investment multiplier tells us that when there is an increment in aggregate investment, income will increase by an amount that is K times the increment of investment.”

According to Prof. Dillard, “Investment multiplier is the ratio of increase in income to a given increase in investment.”

• “Investment multiplier is the ratio of increase in income to given increase in investment.” —Prof. Dillard
• “The multiplier is the number by which the investment can be multiplied in order to get resulting change in income.” —Samuelson
• “Investment multiplier is the coefficient relating to an increment of investment to an increment of income.” —Hansen
• “Investment multiplier tells us that where there is an increment of aggregate investment, income will increase by an amount which is K times the increment of investment.” —Keynes

• The accelerator coefficient is the ratio between induced investment and an initial change in consumption.”
• Assuming the expenditure of ₹50 crores on consumption goods, if industries lead to an investment of ₹100 crores in investment goods industries, we can say that the accelerator is 2.
• Accelerator = `100/"ΔY"` = 2

C = F(Y)

The algebraic expression of consumption function is:
𝐶 = \[\overline{C}\] +𝑏⁢𝑌
Where, C = Consumption
            \[\overline{C}\] = Autonomous consumption,
                                 i.e. consumption at zero level of income
             b = Marginal Propensity to Consume
             Y = Disposable income, i.e. income after tax

P_I = `I / Y`
PI = Propensity to invest, I = Aggregate Investment, Y = Aggregate Income

The relationship between investment and the rate of interest can be written as:

I = f(r)

Here:

• I = Investment, the planned amount of investment; it is the dependent variable.​
• r = Rate of interest; it is the independent variable that influences investment.​

This notation means that the level of investment depends on the rate of interest.

• Economic investment = addition to physical capital + change in inventories — NOT buying shares/bonds​
• Autonomous investment is income-inelastic, welfare-driven, mostly by government; drawn as a horizontal line​
• Induced investment is income-elastic, profit-driven, mostly private; drawn as an upward-sloping line​
• Gross Investment = Net Investment + Depreciation; net investment positive means capital accumulation
• Ex-ante = planned; Ex-post = actual; equilibrium requires ex-ante S = ex-ante I​
• Investment function I = f(r) is downward-sloping — higher interest means less investment​
• Invest when MEI > Rate of Interest; stop when MEI = Rate of Interest​

• Kahn → Employment Multiplier (employment to employment ratio)
• Keynes → Investment Multiplier / Income Multiplier (investment to income ratio)
• The multiplier shows a direct, positive relationship between investment and income.
• The multiplier is always expressed as a ratio: \[\frac{\Delta Y}{\Delta I}\].
• The concept highlights that the final effect on income is always a multiple of the original investment.
• The multiplier process works because one person's expenditure becomes another person's income, which is then partly spent again — creating successive rounds of income generation.