Consumption, Saving, Investment and Multiplier
Senior 5 · Economics
Consumption, Saving, Investment and Multiplier
Lesson 3 of 4
45 min
NISR's accounts record gross capital formation of Frw 7,981 billion in 2025, 34.1% of GDP. Of this, Frw 5,042 billion was construction (roads, buildings, power and water works), Frw 2,487 billion was other fixed capital such as machinery, vehicles and equipment, and Frw 452 billion was added to stocks of goods. Every one of these decisions was a bet on the future: a firm buying a machine expects it to earn more than it costs. This lesson asks what drives such decisions, what holds them back in a developing economy, and how two schools of economists, the classical and the Keynesian, explained them.
Definition
Investment (in economics): spending on new capital goods, such as buildings, machines and infrastructure, and on additions to stocks, which raises the economy's capacity to produce. Buying existing shares or land is not investment in this sense; it only changes ownership.
Gross investment: all spending on new capital. Net investment = gross investment − depreciation (replacement of worn-out capital).
Autonomous investment: investment that does not depend on the level of income, such as public infrastructure. Induced investment: investment caused by a rise in income or demand (Lesson 4, the accelerator).
| Determinant | How it works |
|---|---|
| Expected profitability (MEC) | Firms invest when the expected return on a project exceeds its cost. The higher expected sales and prices, the more they invest. |
| The rate of interest | It is the cost of borrowing, or the return given up by using own funds. A higher rate makes fewer projects worthwhile. |
| Business confidence and expectations | Keynes's "animal spirits": optimism raises investment, fear of a downturn delays it. |
| Growth of demand | Rising sales force firms to expand capacity (the accelerator). |
| Technology | New methods make old machines obsolete and create new opportunities. |
| Cost of capital goods | Cheaper machines, or a stronger currency for imported ones, raise investment. |
| Government policy | Tax incentives, special economic zones, public infrastructure and simple regulations encourage investment; high taxes and red tape deter it. |
| Political and economic stability | Peace, the rule of law and stable prices reduce risk. |
| Availability of credit and saving | Investors need funds; where banks lend little or demand heavy collateral, projects are not started. |
Worked example 1: is the machine worth buying?
A juice processor in Nyagatare can buy a pasteuriser for Frw 10,000,000. It expects the machine to yield Frw 11,200,000 of net revenue over one year, after which it is worn out (illustrative).
Expected return (MEC):
If the bank charges 15%, the interest alone is Frw 1,500,000, more than the Frw 1,200,000 gain. Equivalently, the present value of the yield is Frw, less than the cost: do not invest.
If the rate falls to 10%, the present value is Frw, more than the cost: invest. Rule: invest when .
Worked example 2: ranking projects
Firms in a district have five possible projects (illustrative, cost in Frw million): A 20% (5), B 16% (8), C 12% (6), D 9% (4), E 6% (7).
| Interest rate | Projects with MEC above the rate | Total investment |
|---|---|---|
| 15% | A, B | 5 + 8 = 13 million |
| 10% | A, B, C | 5 + 8 + 6 = 19 million |
| 5% | A, B, C, D, E | 30 million |
The lower the interest rate, the more projects pass the test, so investment demand slopes downward against the interest rate. That ranking of projects by expected return is the MEC schedule.
Classical economists (Adam Smith, David Ricardo, and later Alfred Marshall) saw the rate of interest as the price that balances the supply of saving and the demand for investment funds:
Keynes argued that investment depends on the comparison between the marginal efficiency of capital and the interest rate. Firms invest until the expected return on the last project equals the rate of interest.
Definition
Marginal efficiency of capital (MEC): the expected rate of return on one more unit of capital; formally, the discount rate that makes the present value of a capital good's expected yields equal to its cost. Investment continues until .
| Point of comparison | Classical theory | Keynesian theory |
|---|---|---|
| Main determinant of investment | The interest rate | Expected profitability (MEC) compared with the interest rate |
| How S and I are made equal | The interest rate adjusts | National income adjusts |
| Saving | Depends on the interest rate | Depends mainly on income |
| Response to a slump | Interest rates fall and investment recovers by itself | Investment may stay low; government may need to act |
| Limitation | Possible remedy |
|---|---|
| Low domestic saving, so few funds to lend | Promote saving (Lesson 2); attract foreign direct investment |
| High interest rates and heavy collateral demands | Credit guarantee schemes; a deeper capital market; stable inflation |
| Small domestic markets | Regional integration (EAC, AfCFTA) to reach more buyers |
| Costly energy, transport and water | Public investment in infrastructure, often with private partners |
| Shortage of skilled labour and managers | Technical and vocational education; training linked to industry |
| High risk and uncertainty | Political stability, clear laws, protection of property |
| Slow or costly procedures | Simplified registration, one-stop investment centres, tax incentives such as those offered by the Rwanda Development Board |
Warning
Not every "investment" in daily speech is investment in economics. Buying shares on the Rwanda Stock Exchange, putting money in a savings account or buying an existing house are financial transactions or transfers of ownership. Only the creation of new capital goods or additions to stocks count as investment in national income.
E.Z. Classes, "Marginal Efficiency of Capital (English)". A lecture on Keynes's idea of the MEC as a determinant of investment. As you watch, note how the MEC is compared with the rate of interest, and match it to the downward-sloping MEC curve in this lesson.
Practice
Sources and credits
Written by Ganzaa: the text, both diagrams, the tables, the worked examples and the practice items. The pasteuriser and the five projects are illustrative.
