Investment theory

1. Level of income: A higher level of income in an economy usually encourages more investment. When individuals, businesses, or the government earn more, they have more capital available to invest in productive activities. In addition, higher incomes usually lead to increased demand for goods and services, which can motivate firms to expand production capacity through investment.
2. Marginal Efficiency of Capital (MEC): The marginal efficiency of capital refers to the expected rate of return from investing in capital assets such as machinery, buildings, or technology. If the expected returns are high, investors are more likely to invest because the profits from such investments are promising. Conversely, if the rate of return is low, investment levels may decline due to the unattractiveness of potential gains.
3. Availability of infrastructure: Well-developed infrastructure—such as roads, electricity, water supply, and communication networks—supports investment by reducing operational costs and increasing efficiency. Poor infrastructure discourages investment, especially in sectors that rely heavily on transportation and logistics. Investors are more likely to invest in areas where infrastructure supports smooth business operations.
4. Size of the market (level of demand): The larger the market for goods and services, the greater the incentive to invest. A growing or large consumer base provides a ready demand for products, which encourages businesses to invest in production facilities, research, and distribution networks. On the other hand, a small or stagnant market limits sales potential, thereby discouraging investment.
5. Cost of investment: The cost of acquiring capital equipment, technology, land, and labor directly affects investment decisions. When investment costs are low, businesses are more likely to invest, as the initial expenditure is affordable and risks are minimized. High investment costs, however, may deter investors due to the higher risks and longer payback periods.
6. Government policy: Government actions such as taxation, import duties, subsidies, licensing, and privatization policies significantly influence investment levels. For example, tax incentives and subsidies can attract investors by reducing the cost of doing business, while bureaucratic licensing procedures and heavy taxation can discourage investment. A stable and supportive policy environment encourages both domestic and foreign investments.
7. Rate of interest on borrowings: Interest rates affect the cost of financing investments. When interest rates are low, borrowing money becomes cheaper, making it more affordable for businesses to take loans and invest in expansion or new projects. Conversely, high interest rates increase borrowing costs, discouraging investment as the cost of financing may outweigh the expected returns.

Is the process through which the initial change in income passes through the final stop where all of the income invested is saved i.e. savings is equal to amount invested.

Suppose an investment of 1000 million is invested in road construction is made the investment will change into income when it is received. The money will be used in buying construction material and paying the workers and labors; they receive the money and will consume it and save part of that money. Suppose the MPC is 80% then,

According to the table above the receiver of the table will consume 800 mil and save 200 mil, the receiver of 800 will consume 80% which is 640 and save 160 the process will continue until saving is equal to investment.

The amount obtained at the end of the process can also be obtained using the multiplier formula thus.

There are other forms of multiplier which includes tax, multiplier including.

1. The multiplier assumes that all income is spent on consumption.
2. It assumes MPC is constant
3. It assumes there is no scarcity of goods and services such that any additional income must be spent in consumption,
4. It works in a closed economy where no effect of imported inflation.
5. It assumes that there are no leakages and injections.

1. Lack of well-established capital industries In many LDCs, capital goods such as machinery and equipment are not produced domestically. As a result, most investment projects require importing these goods from developed countries. This creates a leakage in the multiplier process, as a portion of the income generated is spent abroad rather than circulating within the domestic economy. The assumption of no leakages in the basic multiplier model is therefore violated.
2. Lack of entrepreneurial skills LDCs often face a shortage of skilled and experienced entrepreneurs. To implement and manage investment projects, they may rely on foreign experts and professionals. Payments made to these foreign personnel result in income outflows, further weakening the multiplier effect, since the income does not stay within the local economy.
3. Low productivity due to poor technology Most LDCs operate with outdated or inefficient technologies, leading to low productivity and limited output. Consequently, these countries are often forced to import goods and services, causing another leakage in the multiplier process. Instead of creating domestic demand and supply cycles, the increased income ends up fueling foreign production.
4. Poor infrastructure Inadequate infrastructure—such as bad roads, limited electricity, and unreliable communication systems—raises the cost of domestic production and distribution. In some cases, it becomes cheaper to import goods and services than to produce or distribute them locally. This leads to more import leakages, reducing the impact of domestic investment on income growth.
5. Low wages and high debt dependency Workers in LDCs typically receive low wages, which barely cover basic needs. As a result, any additional income they receive may be used to repay previous debts or meet essential needs rather than being spent on new goods and services. This limits the marginal propensity to consume (MPC), which is key to a strong multiplier effect, and reduces the overall expansion of income.

Show the relationship between changes in investment resulting from a change in income. It is brought about as follows, after multiplier process has taken place leading to an increase in income, this income will be invested by investors in different sectors until the amount is over for example:-

If a change in investment of 1000 bring a change in income of 5000 the multiplier process and the 5000 is then invested to bring a total investment at the end of 20,000 then the maceration is 4.

Accelerator is denoted by letter V where V is equal to change in investment over change of income

Where: $v$ is the accelerator coefficient.