2026 How the Macroeconomy Works T1W9 Class Test 2 Mark Scheme

T1W9 Class Test 2 How the Macroeconomy Works – Mark Scheme Raffles Institution Economics Department 1 T1W9 Class Test 2 How the Macroeconomy Works Mark Scheme (a) Explain the factors that affect investment. [10] (b) Discuss the effects of a rise in investment on actual and potential growth of different countries. [15] Part (a) Students are expected to explain interest rate and non-interest rate determinants of investments. They are also expected to use examples to substantiate their explanation. Introduction: Define investment : Investment is the act of  acquiring new fixed capital assets like buildings, plants, equipment and machines (known as ‘ fixed capital formation’) by firms, and  the accumulating of stocks and inventories such as raw materials, semi-finished goods and finished goods held by the producer (known as ‘changes in physical stocks’) to be transformed into final goods and services. Factors that affect investments in a country mainly fall under interest rate and non-interest rate factors. The main theory concerning determination of investment is the Marginal Efficiency of Investment. Body: Requirement 1: Interest rate and how it affects 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 (such as purchase of new machinery, expansion of factory space) 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. Decision making from firm’s POV: 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 (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. At a MEI2

T1W9 Class Test 2 How the Macroeconomy Works – Mark Scheme Raffles Institution Economics Department 2 higher rate of interest, if MEI < r, less investment project will be undertaken as they are less likely to be profitable. When interest rate falls from r0 to r1, 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 from I0 to I1, reflected as movement down the MEI curve. Requirement 2: Non-Interest rate factors affecting investment (Provide 2) 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 due to positive global/local outlook issued by the government , they will have greater confidence in their expected rate of return on investments. Expected rate of return ↑ at every given rate of interest → invest more at every level of i/r → MEI shifts right c) Changes in corporate tax rates Government policies, particularly the reduction in corporate tax to increase competitiveness of doing business in a country. This tax, which is rendered on firms’ profits will lead to rise in after-tax profits for firms operating in the country. This increases firms’ willingness and ability to invest, as expected returns on profits increased at every given rate of interest, leading to an increase in investment expenditure. MEI shifts right d) Changes in technology Improvements in technology stimulate investment spending. Technological improvement (such as improved production process) increase the productivity and efficiency of capital, allowing firms to produce more output or lower unit costs using the same amount of inputs  each investment project is expected to generate higher net profits in the future, leading to an increase in the expected rate of return on investment at every given rate of interest. On top of that, the implementation of new technology often requires new capital - new machinery, equipment or software, raising the attractiveness and viability of investment projects . For instance, advances in the sharing economy have encouraged massive investments in new sectors -the use of idle assets such as cars and spare bedrooms has led to growth of Uber and Airbnb. Consequently, firms are willing to undertake more investment at each interest rate  MEI shifts right 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. Conclusion In conclusion, changes in interest rate and non-interest rate factors will cause investment to rise or fall. The difference is whether it results in a movement along the MEI curve or a shift of the entire MEI curve. Mark Scheme: Knowledge, Application, Understanding and Analysis

T1W9 Class Test 2 How the Macroeconomy Works – Mark Scheme Raffles Institution Economics Department 3 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 of the factors affecting investment. 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 with appropriate use of examples. 8-10 Part (b): Discuss the effects of a rise in investment on actual and potential growth of different countries. 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 • welfare states vs non-welfare states • any other categorization Body: Requirement 1: Discuss the effects of rise in investment on actual growth of countries Thesis: Rise in investment will lead to actual growth (rise in equilibrium real NY) Explain multiplier effect: • [Trigger] Rise in investment will cause an increase in AD. • As I is a component of AD, AD would increase from AD0 to AD1. • The increase in AD would start a multiplier process, which is based on the principle that spending creates income and income generates spending. • [Inventory adjustment]: The increase in AD causes a drawdown on inventories/or shortage and hence, signal to firms to increase production. • Firm then hire more factors of production from households, and in paying households factor incomes , causes national income to increase. • [Repeated rounds]: As national income increases, households spend p