Propensity To Invest

Propensity To Invest

Propensity to Invest term used by Keynes to describe the willingness of private entrepreneurs to spend on capital goods. (Investment by public authorities is determined by political as well as economic influences.)

In Keynesian economic analysis the level of investment depends on profitability, an assessment of which requires a comparison of the outlay required to produce it and the (present) value of the stream of expected future receipts, discounted at an appropriate rate of interest. For example, the present value of Li per annum receivable for twenty years is £12.46 at 5 per cent, £11.47 at 6 per cent, and so on. The rate of interest chosen for the calculation will reflect the rate at which an entrepreneur can borrow in the market, but will normally be higher than this rate to allow for the riskiness and uncertainty of the venture. If the value of the discounted stream of expected receipts is larger than the outlay, the investment is profitable and, other things being equal, will be undertaken.

Profitability may also be assessed by comparing the rate of return on the outlay (expressed as a rate per cent) yielded by the expected flow of receipts with the minimum expected rate of interest. If the rate of return over cost is larger, the investment is profitable.

This second measure is more useful in discussing the influences determining the level of investment. The rate of return over cost to be obtained from additional expenditure on investment of the most profitable type (which Keynes called the 'marginal efficiency of capital') will affect the level of investment. At any time, with a given level of interest rates for borrowed funds, expenditure on investment will tend to be carried to the point at which the marginal efficiency of capital equals the general rate of interest adjusted for risks and uncertainties. As the supply of capital goods increases, higher costs of production and/or lower expected receipts from further output will reduce the marginal efficiency of capital until this equilibrium is reached. The level of investment as a whole, therefore, is determined by (a) the state of expectations, and (b) current interest rates. Given the former, the lower the interest rates the larger the amount of investment. The stimulus to investment from lower interest rates will also depend on the durability of capital goods and the degree of risk. Broadly, the greater the durability and the smaller the risk the stronger the stimulating effect of a downward shift in interest rates; and conversely. Thus, other things being equal, plans for new building are more likely to be affected by changes in interest rates than, say, investment in industrial machinery and equipment.

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