İKTİSADA GİRİŞ II - Deneme Sınavı - 14

INVESTMENTS

Investment expenditures cover the expenses incurred by firms in capital goods and inventories. Among the aggregate expenditures, investments are the most volatile one.

Factors Determining Investments

We have already stated that investment expenditures are made up of expenditures of firms on capital goods and stocks. Capital goods are the equipment they need to carry out production activities and the buildings that firms have. Stocks are composed of final unsold goods. Stocks may be planned or unplanned. For example, a tire firm will start to have enough winter tires in stock from the autumn to meet the winter tire demand which is expected to intensify in the winter months. Otherwise, the firm’s inadequate stock operation can lead to a reduction in sales and loss of revenue. For this reason, the investment made by this firm is a planned inventory investment - that is, a stock change. If the firm wants to keep as few unsold winter tires as possible in its stocks until the month of February, and there are still unsold winter tires in February when it comes, this is an unplanned inventory investment. Unplanned stock changes can be regarded as a sign showing that sales are not as good as expected and that there is too much production in the previous period.

Both types of inventory investments or stock changes are considered investment. However, only planned investments, together with other planned expenditures, are effective in determining the level of equilibrium production in an economy. Unplanned investments and undesirable stock changes do not have any impact on the equilibrium level of income. For this reason, economists are interested in factors that affect planned investments.

Interest Rate: The investment objective of a firm is to be able to obtain profit from this investment. For this reason, the higher the expected profitability of the investments is, the higher the investment amount will be. The main factor determining whether an investment is profitable is the interest rate. Interest rate can be defined as the cost of borrowing funds. A large part of the investment expenditures made by the enterprises is covered by borrowing. If the cost of borrowing, i.e., interest rate, increases, fewer investment projects will become profitable. Accordingly, when the interest rate increases, investment expenditures will decrease and when the interest rate falls, investments will increase.

Expected Profit: We have stated that firms are aiming for profit from investing. It is clear that the profit to be gained from an investment that a firm will realize is not certain. For this reason, in order to determine the appropriate amount of investment, firms use economic analyzing techniques to estimate the cost of the investment and the revenue to be obtained from that investment. For this reason, the factor that determines the amount of investment is the expected profitability of investment. There are a number of factors that affect the expected profitability of investments. These include, for example, entry of new firms into the market, political instability in the country, newly enacted laws, taxes or tax advantages provided by the government and general economic conditions in the world.

Technological Change: One of the main driving forces behind new investments is technological change. Realizing the production of a new product or using a new production technology can be extremely important in terms of staying within the industry. Technology is important for companies as it increases productivity at each stage in production processes. The use of technology also contributes to a reduction in production costs.

Cost of Capital Goods: Another factor that affects investment expenditures is the cost of capital goods. As the price of capital goods increases, the expected profitability of the investment will decrease and a contraction in investment volume will occur. One of the factors that cause rapid change in the cost of capital goods is the government’s tax policy. The investment incentives provided by the government (i.e., the tax deduction of the cost of the investment) will affect the cost as well as the amount of investment. In this sense, a reduction in the cost of the investment will result in an increase in investment expenditures.

Capacity Utilization: If a firm intensively uses the capital stock that it owns, it will want to add that stock. However, if part of the current capital stock is idle, the firm does not tend to make any increase in the capital stock it owns. When we look at the economy as a whole, the fact that the current capacity is used at a higher rate will put pressure on the increase of capital goods production and the expansion of productive capacity. On the other hand, when the capacity utilization rate is low (that is, the amount of plants and equipment that are idle in the economy increases), investment expenditures will also tend to decrease.

Net Export Function

In your textbook, the last column of Table 2.3 contains the net export values defined as the difference between exports and imports. Remember that we assumed export amount as autonomous (independent from domestic income) and imports increase depending on the increase in income. For this reason, the net export volume will decrease as income increases. Given this tendency of net export it is possible to draw the net export function (NX) as in Figure 2.6. This tendency of the net export function, which shows a decreasing sloping pattern, is actually equal to the marginal propensity to import.

Another feature of the net export function is that it is the only component that can have a negative value in aggregate expenditures. We have already mentioned that the negative net export value can emerge in cases where the import volume of the home country exceeds her export volume.

Net export function will move up or down depending on changes in income levels, prices of similar goods, preferences of other countries, restrictions imposed by governments on international trade and foreign exchange rates. For example, an increase in the income of other countries causes an increase in the export volume of the home country and by raising the net export volume, it shifts the net export function upward.

AGGREGATE EXPENDITURE FUNCTION

The aggregate expenditure function is obtained by summing up each of the planned expenditure functions described above. Aggregate expenditures (AE) are composed of consumption (C), investment (I), government expenditure (G) and net export (NX): AE = C + I + G + NX

The aggregate expenditure function (AE) can also be obtained graphically with the vertical aggregation of individual expenditure functions. If we first draw the consumption function (C) and add the 500 TL planned autonomous investments at each level of income, we obtain the C + I curve. Then if we add 700 TL planned government expenditures at each level of income, we get the C + I + G curve. Finally, by adding the net export function that will be realized at each level of income, the C + I + G + NX curve or the AE function is attained.

When we carefully examine the figure, we see that the functions C, C + I and C + I + G are parallel to each other. This indicates that all of the mentioned functions have the same slope, which is equal to the marginal propensity to consume. That is why I and G are autonomous in the model. On the other hand, the slope of the AE function is smaller than the slope of the other functions. The reason is that the net export function has a negative slope. When we add the NX function to the C + I + G function, the slope of the aggregate expenditure function decreases. For this reason, the AE function is more horizontal than the C + I + G function.

Consumption function refers to the positive linear relationship between income and consumption expenditures

Marginal propensity to consumption is 0.70 where consumption expenditures increase by 700 TL in return for increase of every 1,000 TL in income

In a model where marginal propensity to consume is calculated to be 0.70, the marginal propensity to save is 0.30

Average propensity to consume is the following does refer to the ratio of consumption expenditures to income

Average propensity to save is the ratio of savings to income

Marginal propensity to import is the ratio of change in import to change in income

An increase in consumption shifts upwards the aggregate expenditure (AE) function as a whole

Existence of autonomous investment expenditures is the reason for drawing the C +G function parallel to the C + I + G function

If your answer is incorrect, review “Import”.

There may be some economic events that cause the failure of Say’s Law. For example, if the production factors want to save money rather than spend a  portion of their income, then the all return from productions of the firms will not be expended. Therefore, the quantity demanded for goods and services will be lower than the quantity produced. Doğru yanıt " A " dır.

British economist John Maynard Keynes argued that the economic equilibrium, as put forward by Classical economists, does not mean that the level of full employment income is provided at the same time. According to Keynes, equilibrium income can be achieved at the level of underemployment or overemployment. Doğru yanıt " B " dir.

    Equilibrium is the point on which there is no tendency to leave. Doğru yanıt " C " dir.

Accordingly, the level of equilibrium income that emerges shows the level of actual employment in that economy. For this reason, the determination of economic equilibrium based on aggregate demand or aggregate expenditure in the Keynesian model will also form the framework of our analysis of equilibrium income in this section. Doğru yanıt " D " dir.

Leakages are used to denote reductions in autonomous components of aggregate expenditures. It is possible to mention three types of leakages from the income-expenditure flow: savings, taxes and imports for an open economy. Doğru yanıt " E " dir.

In an economy, there is no rule that investments are equal to savings, government expenditures are equal to taxes, and exports are equal to imports. In order for the equilibrium to be realized, the sum of the injections must be equal to the sum of the leakages. Accordingly, the equilibrium condition for an economy can be expressed as the sum of savings (S), taxes (T), and import (IM) should be equal to the sum of investments (I), government expenditures (G), and exports (EX). Doğru yanıt " A " dır.

When the households decide to increase their savings without a change in income level, interesting contradiction called as saving paradox will arise.  Saving Paradox is the reduction in the consumption expenditures and, therefore, income because of rising savings. Doğru yanıt " B " dir.