Investment is defined as expenditure on the creation of new capital assets. It is an addition to an economy’s existing stock of physical or real assets such as machinery, buildings, equipment, raw materials, and so on, which enhances the future productive capacity of the economy. From an economic point of view, investment is classified into two types – autonomous investment and induced investment.
What is an autonomous investment?
As the name suggests, an autonomous investment is self-controlling and independent. When an investment is not influenced by the level of income in the economy, it is known as autonomous investment.
It remains constant irrespective of the level of income in the economy. That is why it is income inelastic.
Autonomous investments are generally undertaken by public authorities such as the Union, State, or local governments. For example, expenditure incurred by central or state governments on public works and other works meant to increase public welfare is of autonomous nature. Such an investment is not induced by any profit motive, rather is done to ensure economic stability.
Economists believe that this kind of investment is usually associated with factors like the development of new resources, growth of population and labor force, and technological inventions or innovations. As a result, autonomous investment applies with greater force in overcoming inflationary or deflationary pressures in the economy, and in ensuring and maintaining full employment. Autonomous investment becomes all the more essential in cases of depression and low demand. This is when governments try to boost the economy and make investments in public utility works such as the construction of roads and railways, schools, hospitals, large-scale technological projects, or the discovery of new resources.
Symbolically, autonomous investment (I) is given as (IO) which is constant.
With income on X-axis and investment on Y-axis, the curve of autonomous investment is a straight line parallel to X-axis as shown in the diagram below:
The volume of autonomous investment remains the same at all levels of income.
What is an induced investment?
Induced investment, on the other hand, is an investment that changes as the level of income increases or decreases in the economy.
Induced investment (I) is given as a function of income (Y), i.e., I = f(Y).
When the level of national income changes, so does the level of induced investment. Thus, it is income elastic.
Most of the investment made by private firms is of induced type. This is so because producers or businessmen are driven by profit motives. When the income levels in an economy increase, demand for goods and services also increases. Therefore, private firms get encouragement to accelerate their business activities, derive greater profits by capitalizing on increased demand, and accordingly invest more in capital stock. Thus, induced investments are directly dependent upon profit expectations.
Besides income, there are some other factors too that affect induced investment. These are fluctuations in raw material prices, wage rate, GDP, interest rate changes, and so on. For example, a steel manufacturer imports raw materials (crude oil) from a foreign country’s supplier and due to a certain global economic crisis, the prices of crude oil go up. Such a rise in prices is likely to adversely impact his business’s profitability and production operations. It may also cause him to sell off some capital assets or lower his investment costs.
With income on X-axis and investment on Y-axis, the curve of induced investment is positively sloped as shown in the diagram below:
With an increase in income levels, profit expectations of producers go up, thereby increasing induced investment.
Relationship between autonomous and induced investment
From the above discussion, it might appear – that there is no relation between autonomous and induced investment. But they are very much related. This can be explained with an example.
Suppose a country’s government undertakes an increase in autonomous investment by 20 crores. Owing to the multiplier effect, assume that it will lead to an increase in overall employment and national income by 40 crores. This increase in income of 40 crores will surely have a positive impact on the spending capacity of people and their consumption expenditure will increase. Now, the increased desire (or demand) for the consumption of goods and services will in turn encourage private investors to make more investments in production processes. Thus, autonomous investment has an indirect effect on induced investment.
In short, an autonomous investment made by public authorities results in creating or controlling income and employment in the economy. This influences the demand and encourages private investors to invest. Hence, the private investments that are induced by profit motive can only be fruitful when the public investment has created a favorable environment for the former. Furthermore, all the factors that affect autonomous investment have an indirect impact on induced investment too.
Comparison table – Difference between autonomous and induced investment
The difference between autonomous investment and induced investment can be summarized in the following table:
|Basis of difference||Autonomous investment||Induced investment|
|Relation with income||Autonomous investment is unaffected by the level of income.||Induced investment is positively influenced by the level of income.|
|Motive||Economic stability||Profit earning|
|Elasticity||Income inelastic||Income elastic|
|Determined by||Consideration of economic welfare||Consideration of profit|
|Investment curve||Horizontal straight line parallel to X-axis||Positively sloped|
Autonomous investment is not influenced by changes in demand. Rather, it influences the demand which in turn influences induced investment.
Autonomous investment example – This could be an investment in economic and social overheads made by the government.
Induced investment example – Opening of new stores at new locations by a retailer.