Start:Intro
-Investment is a form of injection
-Addition to the circular flow of income
-Definition: Total planned expenditure on goods and services.
-Definition of investments: Process of creating capital ( K ) goods.
-Planned expenditure = income.
-J = W
-J = injection = investments + government spending + exports
-W = Savings + taxes + imports
-J increase. J > W
-Expenditure > Income
-Income of firm producing capital goods Increase
-This will spark off another round of consumption
-At the same time, part of the addition Income is withdrawn as savings, taxes and imports.
-Process continues until J = W
-The new equilibrium is at C ( fig 1 ) where the national Income is at Y1 income level.
-Hence, increase in expenditure has incrased national income.
-K = multiplier
-Change in Y= K x Change in I -----------(1) (I suppose Y = national Income while I = investment)
-The value of K is given by eqn 2.
-K= 1/MPW ---------------(2)
-Eqn 2 shows that the lower the marginal propensity to withdraw (MPW), the larger the multiplier. Hence, the larger will be the impact on national I by a given Change in Y.
-However, the AE model is based on the assumption of the excess capacity. This may not be the case in the economy. If I increase but the economy is at full employment already, inflation may result. Thus in this case, the increase in I will not lead to the increase in national Income.
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Sidenote:
-Norminal Income --> How much % Income increase
-Real I --> How much % Income increase and how much % increase in price level. ( Relative. If im not wrong, when the income increase, the real income may not increase due to inflation. )
-Mutiplier effect stops when Change in I = Change in W.
