What is Marginal Propensity To Invest

Marginal propensity to invest is the ratio of change in investment to change in income. The marginal propensity to invest shows how much one additional unit of income will be used for investment purposes. Typically, investment increases when income increases, and decreases when income decreases. The greater the marginal propensity to invest, the more likely it is that additional income is not consumed, but instead invested.

BREAKING DOWN Marginal Propensity To Invest

In Keynesian economics, a general principle states that whatever is not consumed is saved. Increases (or decreases) in income levels induce individuals and businesses to do something with the extra cash. Consumption tends to be impacted more by increases in income, as demonstrated by increased consumption levels when countries develop.

The marginal propensity to save, while typically smaller than the marginal propensity to consume, does have an impact on the multiplier effect and does affect the slope of the aggregate expenditures function. The larger the marginal propensity to invest, the larger the multiplier. For a business, increases in income can be the result of reduced taxes, changes in costs or changes in revenue.

Marginal propensity to invest is calculated as ΔI=/ΔY, meaning the change in value of the investment function (Im) with respect to the change in value of the income function (Y). It is thus the slope of the investment line. For example, if a $5 increase in income results in a $2 increase in investment, the marginal propensity to invest is 0.4 ($2/$5).

How Marginal Propensity to Invest Affects The Economy

In general, an increase in investment spending will employ people immediately in the investment goods industry, and have a multiplied effect, employing some multiple of additional people elsewhere in the economy. This is an obvious extension of the idea that spending on investment will be re-spent. However, there's a limit to the effect. The real output of the economy is limited to output at full employment, and spending multiplied past this point will simply raise prices. If people try to spend the whole of their increased incomes triggered by the increase in investment, without saving any, prices might be induced to rise without limit

Keynesian theory also suggests that any given investment project (public or private) will raise income and employment with the full force of the multiplier because that decision to invest may take the place of investment that would have happened in its absence. For example, funding it might raise interest rates, discourage other investments or compete with other projects for labor.