Answer to Question #50387 in Macroeconomics for abdulla sabit

Question

Explain the relationship between saving and investment. How investment demand curve is derived? What may happen to the position of the investment demand curve if the political situation of the country worsens?

Answer 1

Saving (S) is the part of the income that is not consumed. In other words, saving means reducing consumption. The economic importance of savings lies in its relation to investments, i.e., production of real capital. Savings are the basis for investment. The demand curve for investment sloped descends and reflects the inverse relationship between the interest rate and the total value of the planned investment. In general, the investments are hold by investors primarilyfor profit and as long as there are an unbalanced economy, uncertain political situation and imperfect legislation, the profit is out of the question, and, therefore, there can be no question of a long-term strategic investment. When foreign investors are aware of the political problems in the country, they begin to sell their existing financial assets of the country and acquire assets in another one. The net foreign investments in the country increase, which affects both markets. It is obvious that this development will affect the curve of net foreign investment, which, in turn, will affect the supply of currency of unstable country on the foreign currency exchange market. In addition, since the demand for borrowed funds depends both on domestic and on net foreign investment, "flow" of capital should reflect on the demand curve of market of borrowings. When the net foreign investment increases, the demand for borrowed funds necessary to finance new transactions also increases. Thus, the demand curve of borrowed funds shifts to the right. Due to the fact that net foreign investment increased regardless of the interest rate, they also shift curve to the right.