The Important Terminologies which are used in Investment Function are listed below:
(i) Gross and Net Investment:
Net investment refers to the money value of investment at current prices while gross investment refers to its money value at the time of its inductment in production. Thus the two differ from each other by the magnitude of depreciation.
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Net Investment = Gross Investment – Depreciation
Depreciation represents loss of value of a productive asset in the process of production. The value of a productive asset undergoes continuous erosion as a result of wear and tear caused by its sustained use in production.
To restore the productive efficiency of the asset, expenditure is incurred on it every year. This expenditure serves as a measure of the depreciation. Firms always set aside an amount in the beginning of each year as depreciation allowance for the purpose.
(ii) Autonomous and Induced Investment:
Autonomous investment is that investment which is income inelastic. All the investments made by governments in the public sector are of autonomous character. Such investments are essential for social welfare.
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They do not wait for income to accrue to the investor. Private investment may or may not be of autonomous nature. It could be autonomous provided it is made for reasons other than those of making profits.
Contributions made by firms to the provident fund of the workers qualify as autonomous investment. Such investments are mandatory for the firms at present due to new labour legislation in most of the countries.
Induced investment is an investment that is income elastic or income sensitive. Such investments increase with an increase in income of the investor. Induced investment may be zero at a low level of income, but as income rises, so does the induced investment.
This distinction between the two is demonstrated through Fig. 5.1. Autonomous investment is a horizontal line at all levels of income, while the induced investment is an upward sloping curve.
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Total investment function can be derived through the vertical summation of the autonomous investment and the induced investment.
Here, investment portrayed as a function of income, is called an investment function. The general form of the investment function if is I = f(Y, r), where Y is income and r is the rate of interest. In short run, if income (Y) remains constant investment can be defined as an inverse function of the rate of interest, r.
I = f(r) = Ia-hr
Where, I is autonomous investment, Y is income and ‘h’ is a constant of proportionality. Graphically, investment function given by equation 5.1 can be portrayed as in Fig. 5.3.
(iii) Private and Public Investment:
Investment made in the private sector is known as the private investment. The objective of such investment is generally profit. On the contrary, investment made by government is known as the public investment.
The objective of public investment is social welfare, not profit. Government invests huge amounts in activities of public interest. Construction of roads, stadia, structures for housing schools, colleges, hospitals, etc., are a few examples of public utility projects in which government invests large chunks of public money raised through taxation.