Induced investment vs Autonomous investment

Induced Investment is income elastic, meaning it rises with increasing income and falls with decreasing income. Autonomous Investment, on the other hand, is income inelastic, staying constant regardless of income changes.
Induced investment vs Autonomous investment
3 min
05-July-2024

Induced investment refers to the investment made by businesses that vary with changes in the level of income or economic activity. It rises when income increases and falls when income decreases. This type of investment is directly influenced by the economic environment and consumer demand, thereby making it income-dependent. In contrast, autonomous investment does not depend on income changes. It stays the same regardless of whether income goes up or down.

It is important for investors to understand the difference between autonomous and induced investment to make decisions related to risk and expected returns during different economic conditions. Let’s explore autonomous investment vs induced investment in detail and learn their various implications.

What is induced investment?

Induced investment refers to the investment businesses make based on their profit expectations. Usually, these expectations are influenced by current income levels. For example:

  • Say the income level of people rises.
  • Now, they spend more on goods and services.
  • Anticipating higher demand, businesses will invest more in expanding their operations.
  • They will buy new machinery or open more stores to satisfy this increasing demand.

On the other hand, if incomes fall, businesses will reduce their investments. Hence, we can observe that induced investment increases with rising income and decreases with falling income.

What is an autonomous investment?

An autonomous investment is the type of investment that does not depend on:

  • Current income
    or
  • Economic conditions

It remains fixed or static regardless of the current economic situation. Generally, an autonomous investment represents the essential investments made by the government or private sector, such as spending on infrastructure, healthcare, and education. These investments are made to achieve long-term goals and societal benefits.

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Differences between induced investment and autonomous investment

One of the key differences between them is that induced investment is flexible and reacts to economic conditions, while autonomous investment remains constant and ignores income fluctuations. Let’s understand autonomous investment vs induced investment better through a comparative table:

Aspect Induced investment Autonomous investment
Definition Varies with changes in income and economic activity Independent of changes in income and economic activity
Motive Profit-driven Driven by public welfare, technological progress, and strategic goals
Nature Income elastic Income inelastic
Key determinants
  • National income
  • Consumer demand
  • Interest rates
  • Government policies
  • Technological advancements
  • Research and Development (R&D)
Volatility More volatile and fluctuates with business cycles Stable and less volatile
Impact
  • Short-term economic growth
  • Employment
  • Market expansion
  • Long-term economic growth
  • Innovation
  • Better public services
Example Businesses increased their production levels to meet the higher consumer demand. Government investment in infrastructure like roads and bridges.


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Examples of autonomous and induced investment

To understand this concept better, let us look at some examples showing how autonomous investments contribute to long-term economic stability. In contrast, induced investments respond to immediate economic opportunities and changes in consumer demand.

Some examples of autonomous investment

  • Government infrastructure projects
    • These investments are made to improve public infrastructure and services, such as building roads, bridges, hospitals, and schools.
    • They occur regardless of the current economic climate.
    • For example:
      • The construction of metro trains to improve urban transportation and reduce traffic congestion.
  • Public health initiatives
    • Investments to improve healthcare infrastructure and public health services.
    • For example:
      • The National Health Mission in India, which focuses on improving the availability of quality healthcare in rural areas.

Some examples of induced investment

  • Expansion of production facilities
    • Businesses invest in new factories and equipment to meet rising consumer demand.
    • For example:
      • ABC Electric Vehicle Ltd. increasing production capacity to meet the growing demand for electric vehicles.
  • Retail sector expansion
    • Companies open new stores and enhance distribution networks in response to increased consumer spending.
    • For example:
      • XYZ Electronics Ltd. opening more consumer electronics stores across India to expand its network.

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Determinants of induced investments

It is worth mentioning that induced investments are primarily driven by changes in:

  • Economic conditions
    and
  • Expectations about future profitability

To gain more clarity, let’s look at some key determinants of induced investments:

  • National income levels
    • Higher national income leads to increased consumer spending, which boosts demand for goods and services.
    • Businesses respond by investing in additional capital to meet this demand.
  • Consumer demand
    • Fluctuations in consumer demand directly influence investment decisions.
    • When consumer demand increases, businesses invest more in production.
    • They expand their operations to capitalise on the higher sales potential.
  • Interest rates
    • Lower interest rates reduce the cost of borrowing
    • This makes it cheaper for businesses to finance new investments.
    • On the other hand, higher interest rates deter investment due to the increased cost of borrowing.

Determinants of autonomous investment

An autonomous investment is usually driven by factors other than economic output, such as technological advancements and government policies. For a better understanding, let’s check out some key determinants of autonomous investment:

  • Subsidies and tax incentives
    • Governments can influence autonomous investment by providing financial incentives such as:
      • Subsidies
      • Tax breaks, or
      • Grants to specific industries or sectors
    • Policies that create a favourable business environment (say ease of doing business) encourage autonomous investment.
  • Technological advancements
    • Continuous innovation and investment in research and development (R&D) drives autonomous investment.
    • That is because firms seek to maintain a competitive advantage and gain a technological edge.
    • Also, the adoption of cutting-edge technologies (e.g., AI, automation, renewable energy) requires significant upfront investment, which is often considered autonomous.
  • Expectations of future profitability
    • Positive expectations about future market conditions and profitability lead to proactive autonomous investments in:
      • Capacity expansion
      • Launching new product lines
      • Expanding workforce, and more

Also read: What is induced investment

Relationship between autonomous and induced investment

Autonomous investment refers to expenditures on capital goods regardless of how well the economy is performing. This kind of investment is driven by factors like government decisions or technological advancements and not by the current economic situation.

On the other hand, induced investment depends on the economy's performance and is directly related to the level of:

  • Economic activity
    and
  • Income

It increases when the economy grows and decreases during downturns. Both types of investment are important for maintaining the overall level of investment in an economy.

Implications of autonomous and induced investment

Autonomous investment contributes to economic stability and leads to long-term growth. It ensures consistent capital formation even during economic downturns. Being static and foundational, it helps in future economic expansion by supporting:

  • Infrastructure
  • Technology
  • Public goods

When it comes to Induced investment, it amplifies economic cycles. This type of investment increases during periods of economic growth and contracts during recessions. Thanks to this responsiveness, induced investments usually enhance economic booms. However, they can also worsen downturns and make economies more volatile.

For businesses, it is important to recognise the drivers of autonomous and induced investment. By doing so, companies can benefit from:

  • Autonomous investments to innovate and expand during downturns
  • Induced investments during growth phases by capitalising economic momentum

Conclusion

Both autonomous and induced investments are distinct types of investments made in an economy. Autonomous investment is usually driven by factors like government policies and technological advancements. It remains steady regardless of economic conditions and supports long-term economic stability and growth.

Induced investment, on the other hand, varies with the economic cycle. It increases during growth periods and decreases during downturns, thus contributing to economic volatility.

For investors, it is important to understand the differences between autonomous and induced investment to effectively time their investments and make informed decisions.

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Frequently asked questions

Why is induced investment important?
Induced investments represent the expenditures made by businesses in response to changes in consumer demand or national income. These investments are important as they enhance economic stability, employment, and technological progress.
What is the difference between autonomous investment and induced investment?
One key difference between them is that autonomous investments remain fixed. They do not change in response to economic conditions and income levels. In contrast, induced investments are directly related to economic conditions. They increase when the economy grows and decrease during downturns.
What happens when autonomous investment increases?
When autonomous investment increases, it positively affects employment, economic growth, and infrastructure development. Resultantly, it helps in developing a more prosperous economy.

What is an example of autonomous spending?
A classic example of autonomous spending is the government’s expenditure on a country’s infrastructure projects like bridges, highways, or public transportation. Such spending is usually driven by welfare motives considering public priorities.

Can autonomous and induced investment have different drivers?
Yes, autonomous and induced investments have different drivers. Usually, an autonomous investment is driven by factors like government policies and technological advancements, while induced investment depends on economic activity and income levels.
Are autonomous and induced investment concepts from macroeconomics?
Yes, autonomous and induced investments are concepts from macroeconomics. They help explain different types of investment behaviours and their impact on the overall economy.
Can autonomous and induced investment occur simultaneously?
Yes. In fact, both types of investments often happen together with autonomous investment providing a stable base and induced investment changing as per the prevailing economic conditions.

Do autonomous and induced investments have different effects on economic growth?

Yes, both autonomous and induced investments have different effects on economic growth.

Autonomous investment provides a stable foundation for growth, while induced investment amplifies economic cycles by fluctuating as per the needs of the economy.

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Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.