Investment in an Uncertain World Essay Example | Topics and Well Written Essays - 2000 words

Investment in an Uncertain World - Essay Example10,000,000 = 6,000,000 + 1,000,000 + G G = 10,000,000 6,000,000 1,000,000 = G = 3,000,000 G as a percentage of GDP = (G divided by Y) and multiplied by 100. =(3,000,000/10,000,000) *100 = = 30 per cent. (ii) Calculate households nest egg as a percentage of GDP. Explain your calculations. (6 marks) In this situation, Y = C + I + G (Savings = Investment = Gross Capital Formation) Therefore, Y = C + S + G. And S as the percentage of Y = (S/Y)* 100 = (1,000,000/10,000,000) *100 = = 0.10 * 100 = 10 per cent Therefore, households savings are 10 per cent of GDP. 1b. Now hypothesise an unexpected shock to the economy (not predicted by the majority of economists and other experts), which hits households confidence so that they increase their savings until these amount to 25 per cent of GDP. (i) Under recounts Law, what is the mechanism by which firms investment is expected to change and what volition its new value be? J. B. Say, a French classical economist, says supply creates its aver demand until the equilibrium amidst the two is reached. By extension, Says law also applies to money market. When there is a glut of savings, there will be more supply of money than demand. As a result, interest rate for borrowing will come down and investment will increase. In this given case, since the savings have increased to 25 percent of GDP, investment should also increase by the same ratio of GDP. Thus, market finds the equilibrium between demand and supply for money through variations in interest rate. (ii) According to the demand-side rise, explain why firms might not necessarily adjust their investment plans. The demand-side approach argues that investors do not automatically make their investment because demand has increased. To invest, they have to be confident about the future for the demand to sustain. Investments are often vast term about which we know very little. Keynes says, If we speak frankly, we have to adm it that our basis of knowledge for estimating the yield 10 year hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes nonentity (Keynes, quoted in Walsh, 2008, p. 63). In such a situation of uncertainty, the animal spirit of investors drives investors to invest. Investors wait for that spirit, which gives them confidence, to develop before they invest. This explains the fluctuation in investments and departure from the supply-demand equilibrium. For instance, in the 1999 recession, the decrement in output of 1.4 per cent coincided with an 8.1 percent fall in investment (Trigg, 2010, p. 230). In conclusion, investors do not make adjustments in their investment plan until they are confident about making money. (iii) If firms did not change their investment plans, explain what would be the consequences for bailiwick income and how fiscal policy might be used to men tion this situation. (11 marks) Investment has a direct impact on national income, and fiscal policy often encourages firms to invest in order to restore the gap between savings and investment. Government expenditure is one of the key components of national income. When government increases its expenditure, national income rises when it decreases its spending, national income also declines. Government thus can influence national income. Classical economics believes that savings and