If households expect lower interest rates in the future, this causes their consumption function to shift down today. The second component of aggregate expenditure. It is not buying and selling of stocks and other financial assets. It consists of spending on new factories, new equipment, new housing, and increasing inventories. Investment is undertaken when managers will believe that this will increase the firm s profit.
Investment shows very little relationship to the amount of income in the economy.
Investment depends more on business expectations and interest rates. Planned investment is unrelated to current level of disposable income. It is said that investment is autonomous with respect to income. Two important determinants of planned investment are interest rate and business expectations. If the interest rate rises, the cost of borrowing money increases and this increases the opportunity cost of investment.