RI 2025+How+the+Macroeconomy+WorksMark+Scheme

T1W9 Class Test 2 How the Macroeconomy Works - Mark Scheme © Raffles Institution 1 T1W9 Class Test 2 How the Macroeconomy Works Mark Scheme (a) Explain the factors that affect investment and exports. [10] (b) Discuss the effects of a rise in investment on actual growth and potential growth of different countries. [15] Part (a) Students are expected to identify and explain 2 determinant s of investments and exports. They are also expected to use examples of substantiate their explanation. Introduction: Definition of key terms: • Investments is the act of acquiring new fixed capital assets like buildings, plants, equipment and machineries by firms (also known as ‘fixed capital formation’). Investment also includes the accumulation of stocks and inventories such as raw materials, semi -finished goods and finished goods held by the producer (also known as ‘changes in physical stocks’). • Exports refer to the spending of domestically produced goods and services by foreigners (export revenue). There are many factors that affect investments and exports in a country. Body: Requirement 1: Explain factors affecting Investment a) Changes in interest rates According to the Marginal Efficiency of Investment (MEI) theory, there is an inverse relationship between interest rate and investment. The MEI refers to the expected rate of return (or profit) of an additional unit of investment while the rate of interest (r) refers to the cost of borrowing. At any instance, there will be many investment opportunities with varying MEI or expected rate of returns. By ranking such investment opportunities from highest to lowest MEI, a downward -sloping MEI curve will be derived as seen in below figure. To decide whether to undertake an investment project, the rational firm will conduct a cost -benefit analysis. A firm will only invest if it makes a profit - meaning that the expected rate of return of investment MEI2

T1W9 Class Test 2 How the Macroeconomy Works - Mark Scheme © Raffles Institution 2 (i.e. MEI) must be greater than or at least equal to the cost of borrowing for investment (i.e. the interest rate). If MEI ≥ r, firms will undertake the investment. If MEI < r, firms will not undertake the investment. When interest rate falls, there will be more investment projects that would yield a MEI or expected rate of return that is greater than or equal to the new lower interest rate and thus cause the level of investment to increase, ceteris paribus. b) Changes in business confidence and expectations Business confidence refers to how optimistic firms are about their future sales and the level of economic activity. Firms form their expectations by looking at the current state of the economy, political factors, and global situation. If firms become more optimistic about future sales and economic activity, they will expect the rate of return on investments to increase, causing investment to increase. c) Changes in corporate tax rates If the government reduces the corporate tax on profits of businesses, firms’ after -tax profits increase. This increases firms’ willingness and ability to invest, leading to an increase in investment expenditure. d) Changes in technology Improvements in technology stimulate investment spending. This is because the implementation of new technology often requires new capital. For instance, advances in the sharing economy have encouraged massive investments in new sectors -the use of idle ass ets such as cars and spare bedrooms has led to growth of Uber and Airbnb. The above factors will result in a shift of MEI curve to the right (MEI to MEI2): Even when interest rates are unchanged (r0), a rightward shift of the MEI curve will increase investment from I0 to I1. Requirement 2: Explain factors affecting Exports a) Changes in national income of trading partners • A decrease in the income levels of trading partners can decrease exports. • For example, if trading partners of Singapore (e.g. the US) enters a recession • They would experience negative economic growth o Previous events that have severely impacted Singapore include the 08-09 US Financial Crisis and the more recent COVID -19 Pandemic which caused recessions in many of our trading partners • This means that average incomes will decreases, which decreases their purchasing power • Assuming Singapore exports are normal goods YEDx > 0, the demand for exports will decrease leading to lower export revenue. • Therefore, falling income levels of one’s trading partners will cause export revenue to decrease. b) Changes in relative price levels between countries • If the price level in one country rises relative to her trading partners, then in the world market, the demand for its goods and services will fall if they are substitutes to the foreign goods and services produced by the foreign countries. o For example, in a country with an ageing population such as Singapore, the number of workers entering the labour force is less than the workers leaving the labour force though retirement. o Moreover, the Singapore government has also slowed down the intake of foreign workers in many sectors including construction and F&B.

T1W9 Class Test 2 How the Macroeconomy Works - Mark Scheme © Raffles Institution 3 o This might cause AS to fall and the GPL to rise. • This would cause the domestic exports have become relatively more expensive compared to its foreign substitutes which reduces our export competitiveness • Thus, the export revenue of the country will decrease. c) Changes in foreign exchange rates • Changes in foreign exchange rates affect the price of imports in terms of domestic currency and the price of exports in terms of foreign currency. • If the Singapore dollar depreciates relative to that of its trading partners, Singapore’s goods and services become cheaper in terms of foreign currency. • This results in foreigners switching towards purchasing more of Singapore’s goods (i.e. Singapore’s exports) which increases Singapore’s domestic export revenue. • This could result in a rise in exports. Conclusion In conclusion, there are many factors that results in changes in investments and exports. Apart from (whatever factors that students explained), there are other factors including (suggest other factors not explained). Mark Scheme: Knowledge, Application, Understanding and Analysis L1 For an answer with m ostly irrelevant with few valid points made incidentally regarding investment and net exports. Contains conceptual errors. 1-4 L2 For an answer with some explanation the factors affecting investment and net exports. Examples are not used consistently throughout the answer. 5-7 L3 For an answer with a clear and detailed explanation of the factors affecting investment and net exports with the use of examples. 8-10 Part (b) Introduction Define key terms: • Investments is the act of acquiring new fixed capital assets like buildings, plants, equipment and machineries by firms (also known as ‘fixed capital formation’). Investment also includes the accumulation of stocks and inventories such as raw materials, semi -finished goods and finished goods held by the producer (also known as ‘changes in physical stocks’). • Economic growth – sustained increase in real GDP. • Actual growth – increase in real NY/GDP • Potential growth – increase in productive capacity – increase in the level of output that can be produced in the economy when resources are fully utilized. Interpret the question: • An increase in investment would have a positive effect on both actual and potential growth. • However, the extent of this impact will differ between countries: • developing vs developed countries

T1W9 Class Test 2 How the Macroeconomy Works - Mark Sc