Optimal Flow of Investment and Stock of Capital - Essay Example

An optimal flow of investment and optimal stock of capital

From the economic perspective, an optimal flow of investment is the maximum value of cash flows a given investment can yield pursuant to the cash flow multiplier of optimal investment policy. Conversely, an optimal stock of capital is the optimum firm’s amount of capital that is represented by the value of issued preferred and common stock i.e. preference shares and ordinary shares.

Keynes’s conflation of investment being a mere homogeneous component of aggregate demand

According to macroeconomics, aggregate demand is defined as being a total demand for services and goods that are final in an economy at some point in time.  Although the effect of the aggregate demand curve is the same as the demand curve, it shows the amount that the government and businesses are willing to spend on goods (Perelman, 2007). Keynes postulates that the capital investment in equipment, plant, and machinery will increase the production of goods in an economy.

 He further, says that investment consists of spending on stocks and finished goods. An increase in interest rate results in a decrease in investment hence a consequent decrease in the total demand. This happens on the ground that the interest rate and investment have an inverse relationship. The increase in interest rate increases the cost of capital hence decreasing demand total. However, a reduction in interest rate will lower the cost of the capital hence an increase in investment and a consequent increase in aggregate investment.

Keynes further ascertained that investment cannot, therefore, be a sole determinant of aggregate demand. This means that a change in investment leads to a less proportionate change in aggregate demand.

Additionally, the increase in the flow of investment increases the money supply in the economy leading to a shift of the money supply upwards and leftwards. This would consequently lead to an increase in prices and the real output (oil, petrol, and diesel)