The document discusses factors that can affect the level of investment in a country. It defines investment and lists several factors including interest rates, business expectations, cost and availability of capital goods, government policies, level of technology, and changes in national income. The document explains how interest rates and business expectations, specifically current demand and political stability, can impact the marginal efficiency of investment and expected returns, thus affecting investment levels.

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.

4. 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

5. 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.

6. 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).

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.