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  • 1. Essay Question a) Explain the factors that could affect the level of investment in a country. [10]
  • 2. Explain the factors that could affect the level of investment in a country. [10] Introduction: oState focus of question: To analyse the factors that would affect the level of investment in a country. o Include key definitions: Define “Investment” an state the types of investment: Investment refers to the acquisition of new fixed capital assets (including housing, plants and machinery) and accumulating inventories (raw materials, semi-finished goods and finished goods held by the producer) Economists usually term them as ‘fixed capital formation’ and ‘changes in physical stocks/inventory stocks’ respectively.
  • 3. Main Development Factors affecting Investment Interest rate Biz Expectations Cost & Availability of Capital Goods Non- Interest rate Level of Technology Govt Policies Changes in National Income Explain 2-3 of these non-interest rate factors
  • 4. Main Development Factors affecting Investment Interest-Rate & MEI According to the MEI Theory, there is a systematic relationship between the rate of interest and the amount of investment that can be profitably undertaken at a particular time. In deciding on whether it is profitable to invest or not, the firm can compare the marginal efficiency of investment (MEI) which is expected rate of returns on investment with the rate of interest, the cost of the investment.
  • 5. Main Development Factors affecting Investment According to MEI Theory, a firm will only invest if the MEI/rate of return of an additional unit of investment is equal to or greater than the prevailing interest rate. Firms will only invest if the MEI/rate of returns of investments is greater than or equal to the cost of investments (which is the interest rate).
  • 6. Main Development Factors affecting Investment Referring to Figure 1, when interest rate falls from r1 to r2, investment increases from I1 to I2. This is because projects that were previously unprofitable are now profitable as the costs of interest payments falls. As such, firms will undertake more projects, resulting in an increase in investment.
  • 7. Main Development Factors affecting Investment Evaluation In Singapore, it is reckoned that firms in the manufacturing sector may be relatively less affected by interest rate increases, as the sector is dominated by multinational corporations which rely on their own sources of funds, e.g. from head offices. In contrast, companies in the building and construction sector may be more severely affected as they are more reliant on bank borrowing.
  • 8. Main Development Non- interest rate factors affecting Investment Business Expectations may depend on: i) Current demand If current demand for the goods produced by the firm is good and has been always good for some time, future prospects probably look good and investment increases (MEI would shift to the right). On the other hand, when current demand or sales are falling, businessmen would expect that there would be bad times ahead and they would invest less (MEI would shift to the left). ii) Political situation With political stability, the expected return of investment would increase and this would in turn encourage investment. On the other hand, if there is political instability, the expected return of investment would be reduced and this would in turn discourage investment.
  • 9. Main Development Non- interest rate factors affecting Investment Cost and Availability of Capital Goods If there is a fall in the cost of new plant and equipment, firms’ investment will increase. Investment goods can become relatively cheaper, even if its price remains unchanged, if labour costs increased. Labour-saving investment may increase. The level of technology When technology advances, i) the expected return of investment would most probably increase and ii) lower the cost of machinery. As a result of this, investment will increase and hence MEI to shift to the right i.e. a higher level of investment at every level of interest rate.
  • 10. Main Development Non- interest rate factors affecting Investment Changes in National Income Change in national income is one of the causes for changes in net investment. When income rises at an increasing rate, net investment rises. The larger the increase in income, the more investment will be needed in order to produce more goods.