Some of the major factors which affect the inducement to invest are discussed below:
According to Keynes, the MEC is more volatile than the rate of interest. This is because the prospective yield of capital assets depends upon the business expectations. These business expectations are very uncertain. “They may change quickly and drastically in response to the general mood of the business community, rumours, news of technical developments, political events, even directors’ ulcers may cause a sudden rise or fall of the expected rate of yield.”
As a result, it is difficult to calculate the expected annual returns on the life of a capital asset. As Keynes himself wrote, “If we speak frankly we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the city of London amounts to little and sometimes nothing, or even five years hence.”
Further, because of uncertainty, investment projects usually have a short pay-off period. Capital assets become obsolete earlier than their expected life due to rapid technological developments. The rate of depreciation also does not remain constant and varies much. So firms have a tendency to invest only if they are in a position to recover the capital outlay in a short period. These factors tend to bring instability in the investment function.
If the existing stock of capital goods is large, it would discourage potential investors from entering into the making of goods. Again, the induced investment will not take place if there is excess or idle capacity in the existing stock of capital assets.
In case the existing stock of machines is working to its full capacity, an increase in the demand for goods manufactured by them will raise the demand for capital goods of this type and raise the inducement to invest. But it is the capital stock which influences the MEC. The MEC and the capital stock are inversely related.
If the level of income rises in the economy through rise in money wage rates and other factor prices, the demand for goods will rise which will, in turn, raise the inducement to invest. Contrariwise, the inducement to investment will fall with the lowering of income levels.
The present and future demand for the products greatly influences the level of investment in the economy. If the current demand for consumer goods is increasing rapidly more investment will be made. Even if we take the future demand for the products, it will be considerably influenced by their current demand and both will influence the level of investment. Investment will be low if the demand is low, and vice versa.
The amount of liquid assets with the investors also influences the inducement to invest. If they possess large liquid assets, the inducement to invest is high. This is especially the case with those firms which keep large reserve funds and undistributed profits. On the contrary, the inducement to invest is low for investors having little liquid assets.
Inventions and innovations tend to raise the inducement to invest. If inventions and technological improvements lead to more efficient methods of production which reduce costs, the MEC of new capital assets will rise. Higher MEC will induce firms to make larger investments in the new capital assets and in related ones.
The absence of new technologies will mean low inducement to invest. An innovation also includes the opening of new areas. This requires the development of means of transport, the construction of houses, etc., leading to new investment opportunities. Thus inducement to invest rises.
The nature of new products in terms of sales and costs may also influence their MEC and hence investment. If the sale prospects of a new product are high and the expected revenues more than the costs, the MEC will be high which will encourage investment in this and related industries.
For example, the invention of television must have encouraged the electronics industry to invest in these capital assets and used them to produce television sets, if they had expected profits to be higher than costs. Thus lower maintenance and operating costs in the case of new products are important in increasing the inducement to invest.
A rapidly growing population means a growing market for all types of goods in the economy. To meet the demand of an increasing population in all brackets, investment will increase in all types of consumer goods industries. On the other hand, a declining population results in a shrinking market for goods thereby lowering the inducement to invest.
The economic policies of the government have an important influence on the inducement to invest in the country. If the state levies heavy progressive taxes on corporations, the inducement to invest is low, and vice versa. Heavy indirect taxation tends to raise the prices of commodities and adversely affects their demand thereby lowering the inducement to invest, and vice versa.
If the state follows the policy of nationalisation of industries, the private enterprise would be discouraged to invest. On the other hand, if the state encourages private enterprise by providing credit, power and other facilities, inducement to invest will be high.
Political conditions also affect the inducement to invest. If there is political instability in the country, the inducement to invest may be affected adversely. In the struggle for power, the rival parties may create unrest through hostile trade union activities thus creating uncertainty in business.
On the other hand, a stable government creates confidence in the business community whereby the inducement to invest is raised. Similarly, the danger of a revolution, or war with some other country has an adverse effect on the inducement to invest, whereas peace and prosperity tend to raise it.