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Explain how changes in investment expenditure results in a larger change in national income. [10]

Investment refers to the part of the aggregate demand or expenditure that is spent on the production of capital equipment or infrastructure that will produce goods for consumption. The rise in investment will lead to a rise in national income and this can be explained by the multiplier process through the AD-AS diagram.

Main Body

1. Explain how private investment (FDI/Local Investment) can be increased.

Investment can be classified into domestic or foreign direct investment (FDI). Regardless of the form of investment, the investors are motivated by profitability which his determined by the market revenue and cost of production. Factors such as taxation and subsidies, efficiency gained from infrastructural development, productivity and cost of labor will affect cost of production while factors such as the state of economic development and political stability will affect the market revenue of the economy. As a result, the introduction of policies and economic activities that influence the market revenue to increase and cost of production to decrease will help raise profitability to increase investment and thus, contributing to a higher level of national income.

2. Explain how private investment will lead to an increase in national income (real GDP via the multiplier process and in the long run via potential growth)

The increase in investment will lead to a rise in aggregate demand which will contribute to a rise in real GDP via the multiplier process. In the multiplier process, the initial increase in the aggregate expenditure expands the circular flow of income, increasing the income of the factor earners to further expand the circular flow of income with new will co transactions. As long as transactions are made, the circular flow of income will continue to expand until the withdrawal effects is equal to the initial injections which will crease the expansion of the circular flow of income. Consequently, the national income will increase by several folds, depending on the value of the multiplier which is determined by the sum of Marginal Propensity to Withdrawal (MPW) that consists of Marginal Propensity to Save, Tax and Import. (MPW = MPS+MPS MPT+MPM).

The increase in investment expenditure also involves infrastructural development and research and development (R&D) that leads to an expansion of resources, made possible with high degree of mobility of resources that the economy can attain with more infrastructures

As a result, efficiency of production is raised, allowing firms to produce more with the same units of resources, thus attaining potential growth, as seen by the rightwards shift of the Production Possibility Curve (PPC).

Economics Tuition - National Income Accounting and Economic Growth - Q5a - Sustainable Economic Growth Diagram

As seen from the diagram, the increase in investment expenditure will induce a rise in aggregate demand from AD0 to AD1, contributing to a rise in real GDP from Y0 to Y1 and a rise in GPL from P0 to P1. Since the increase in investment expenditure also leads to the expansion of resource capacity, the aggregate supply will shift to the right from LRAS0 to LRAS1, whereby the full employment is raised from YF1 to YF2, lowering the cost condition, which will induce an increase in aggregate demand on a quantitative basis and thus, raise the real GDP from Y1 to Y2 with a reduction in GPL from P1 to P2. Hence, sustainable economic growth is attained.

3. Evaluate the key determinants of the impact on national income.

The increase in investment is of great significance in determining the value of increase in national income as the increase in national income will mean an increase in employment. This will subsequently raise national income which will lead to higher disposable income and thus, raises consumption which will further increase national income.

The rise in investment is also a significant influence on the future value of national income as it will affect the potential production capacity since it affects the availability of resources.

It is also notable that the rise in investment with high-valued production will be a significant influence in raising a larger increase in national income as the contributions to production involves high-valued products.

Given this understanding of the change in investment on the change in value of national income, it can be observed that the value of multiplier plays a very significant role in the extent of increase in national income when there is an increase in investment. It is also notable that the nature of investment will also be significant in determining the extent of increase in national income since investment in high-valued industries will promote high-valued contributions to change in national income.

In sum, the essay has shown how increase in investment has led to a larger rise in national income and the main source of influence in this economic process to raise national income. Thus, this will provide understanding on how the government can introduce policies to raise investment to promote larger increase in national income.

Simon Ng

Founder, JC Economics & General Paper Tutor at Economics Focus
JC Economics Tutor Simon Ng of Economics Focus has been teaching A Level Economics and A Level General Paper since 2003. Simon set up Economics Focus to assist students in their pursuit of academic excellence at the examination by providing economics tuition for H1 and H2 students. JC1 and JC2 students are inspired by Simon's clear teaching methods that enabled them to comprehend economics terms and concepts. Simon developed the Rational Thinking methodology to aid students to excel in their JC economics essays and CSQs.