How does an increase in investment affect the economy?
Define what investment is: spending by firms on capital goods (eg. machinery). Then analyse the effect of the change in the question: Investment is component of the equation Y=C+I+G+NXIncreasing investment therefore increases income (Y). This leads to a shift in the AD-AS diagram of the AD curve to the right. This may lead to increase in inflation. It is important to evaluate your answer: If you are using the Keynesian AD-AS model, the change in GDP and price level due to the shift in AD will depend on the amount of spare capacity in the economy. Also, the size of the shift in AD will depend on the the size of the increase in investment and the size of the income multiplier (1/1-MPC).
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