Korney's investment demand theory

Keynes’ Theory of Investment Demand

Introduction

The economic theories of John Maynard Keynes have had an immense influence on the post World War II economic landscape. His theories have had an impact on the lives of people all over the world as it has shaped the policies of governments, shaped policy decisions and shaped the way we think about economics. One of the most significant economic theories developed by Keynes is the theory of investment demand, which attempts to explain how the level of investment in an economy is determined.

Summary

John Maynard Keynes’ theory of investment demand attempted to explain how the amount of investment within an economy is determined. According to Keynes, investment is determined largely by “animal spirits” – essentially the psychology of investors, who may choose to invest or not invest depending on their confidence in the prospects for success. He also argued that the level of investment in an economy is affected by the levels of profitability and the “margin of safety” – the difference between the current cost of the investment and its expected future returns. Keynes argued that the interest rate was a major factor in determining the level of investment, as it entices investors to take on greater risk and thus invest more. Finally, he argued that taxes were also a major factor in determining the level of investment in an economy, as they can both decrease the amount of taxable income (and therefore the amount of investment) and increase the cost of investment.

Analysis

Keynes’ theory of investment demand was incredibly influential in shaping economic policy and was even adopted by the American government in its post-war recovery efforts. Keynes argued that to increase the level of investment in an economy, a government should target policies to increase confidence in investors, as well as reduce taxes and interest rates. This idea of stimulating investment through government policy has since been adopted by numerous countries in their efforts to stimulate economic growth.

The theory of investment demand was also influential in shaping the way economists think about investment. Keynes’ theory of investment demand emphasized the role of psychology and ignored the traditional classical economic theories that focused on the “fundamental economic determinants” of investment. This shift in approach allowed economists to better understand the psychology of investment and therefore tailor their economic policy accordingly.

Conclusion

John Maynard Keynes’ theory of investment demand is one of the most influential economic theories of the twentieth century. His theory attempted to explain how the level of investment in an economy is determined and had a major impact on the post-war economic policy of governments. Keynes’ theory also emphasized the role of psychology and the role of government policy in creating the desired level of investment. His theories were immensely influential in creating the modern economic landscape and are still relevant today.

The Investment Demand Curve by Knut Wicksell serves as a theory of the key forces behind economic cycles and integrates consumer spending with business investments. It states that a decrease in consumer spending will lead to a decrease in aggregate production, which in turn will lead to a decrease in business investment, due to the increase in uncertainties and the lack of consumer demand.

When consumer spending decreases, businesses are more reluctant to invest due to the risks associated with unpredictable consumption. To increase investment activity, business owners then require a more attainable return on their investments, so in an effort to drive down the cost of capital, they can borrow funds at lower interest rates. The reduction in cost of capital then compels a business to expand production and hire new employees, thus increasing overall economic output.

In addition, the Investment Demand Curve posits that in a situation where there is increased consumer spending, businesses are more willing to invest and will require higher returns on their investments. This in turn leads to higher interest rates, which makes it harder for businesses to finance their investments and an ultimately an increase in aggregate production. This thus creates a cycle that links changes in consumer demand with the changing levels of production.

It is worth noting that during a recession, the Investment Demand Curve could be used to formulate a policy to boost economic investments and production levels. By lowering the cost of capital through interest rate reductions, businesses could borrow to finance their investments, and thus increase production and employment. This in turn would stimulate consumer spending, and the cycle would continue.

To summarise, the Investment Demand Curve by Knut Wicksell explains how changes in consumer spending lead to fluctuations in production and business investments. It suggests that reducing the cost of capital and stimulating consumer demand are essential to economic expansion.