Q.95 investment-and-singapore
-
Upload
omer-mirza -
Category
Economy & Finance
-
view
170 -
download
0
Transcript of Q.95 investment-and-singapore
© 2011 Economics Cafe All rights reserved.
Written by: Edmund Quek
(a) What are the determinants of investment expenditure in Singapore?
[10]
(b) Discuss whether an increase in the investment expenditure in Singapore is desirable
for the economy?
[15]
(a) Investment expenditure is the expenditure made by firms on goods produced not
for their present use but for their use in the future. When discussing the determinants of
investment expenditure, it is useful to distinguish between autonomous investment and
induced investment as they have different determinants.
Autonomous investment is the part of investment that does not depend on
national income and is determined by interest rates, business sentiment, business
costs, capital costs, corporate income tax, technological advancements and the
availability of credit. The investment function shows the investment expenditure of
firms at each interest rate. According to the marginal efficiency of investment theory, the
marginal efficiency of investment function is the investment function. A fall in interest
rates will lead to more profitable planned investments resulting in an increase in
investment expenditure and vice versa. An increase in investment expenditure due to a
fall in interest rates can be shown by a downward movement along the marginal
efficiency of investment function.
In the diagram above, a fall in the interest rate (r) from r0 to r1 leads to a downward
movement along the marginal efficiency of investment function (MEI) resulting in an
increase in investment expenditure (I) from I0 to I1. However, a change in interest rates in
Singapore will not lead to a significant change in the investment expenditure as most of
the investments are made by foreign firms with foreign sources of funds. In Singapore,
the major determinants of autonomous investment are business sentiment and corporate
© 2011 Economics Cafe All rights reserved.
Written by: Edmund Quek
income tax. For instance, the Singapore economy is rather export-dependent due to the
small domestic sector. Therefore, a strong external economic environment of Singapore
will lead to stronger business sentiment. When this happens, expected returns on planned
investments in Singapore will increase which may lead to a large increase in the number
of profitable planned investments and hence the investment expenditure. Most of the
investments in Singapore are made by large foreign firms which earn high corporate
income. Therefore, a decrease in corporate income tax which will increase expected after-
tax returns on planned investments in Singapore may result in a large increase in the
investment expenditure. Although business costs, capital costs, technological
advancements and the availability of credit also affect investment expenditure in
Singapore, they are minor determinants. For instance, business costs and capital costs in
Singapore are generally stable. Therefore, they rarely change substantially. An increase in
investment expenditure due to a non-interest rate factor can be shown by a rightward shift
in the marginal efficiency of investment function.
In the above diagram, a rightward shift in the marginal efficiency of investment (MEI)
function from MEI0 to MEI1 leads to an increase in investment expenditure (I) from I0 to
I1 at the same interest rate (r0).
Induced investment is the part of investment that depends on national
income. According to the accelerator theory of investment, net investment is determined
by the rate of change of national income. When national income rises at an increasing
rate, net investment will increase. However, when national income rises at a decreasing
rate, net investment will decrease. The size of the accelerator effect depends on the
capital-output ratio. The higher the capital-output ratio, the larger the accelerator effect.
In Singapore, the capital-output ratio is high and hence the accelerator effect is large.
In conclusion, investment expenditure is a volatile component of aggregate
demand in Singapore. Therefore, the Singapore government should control investment
expenditure to maintain the good health of the economy.
© 2011 Economics Cafe All rights reserved.
Written by: Edmund Quek
(b) The effects of an increase in the investment expenditure in Singapore on the
economy can be discussed in terms of the effects on the balance of payments, the national
income, unemployment and the general price level.
An increase in the investment expenditure in Singapore may lead to an
improvement in the balance of payments. The balance of payments is a record of all
the transactions between the residents of the economy and the rest of the world over a
period of time and is made up of the current account and the capital and financial account.
If the increase in investment expenditure in Singapore is due to an increase in inward
foreign direct investments, the capital and the financial account and hence the balance of
payments will improve.
An increase in the investment expenditure in Singapore will lead to an
increase in the aggregate demand and hence the national income. Aggregate demand
is the total demand for the goods and services produced in the economy over a period of
time and is comprised of consumption expenditure, investment expenditure, government
expenditure on goods and services and net exports.
In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to
an increase in national income (Y) from Y0 to Y1. When aggregate demand rises, firms
will employ more factor inputs to produce more output and hence pay more factor
income to households. Household income and hence consumption expenditure will rise.
Due to the increase in consumption expenditure, firms will employ even more factor
inputs to produce even more output and hence pay even more factor income to
households. Household income and hence consumption expenditure will rise further.
Therefore, an increase in aggregate demand will lead to a larger increase in national
income and this is commonly known as the multiplier effect.
© 2011 Economics Cafe All rights reserved.
Written by: Edmund Quek
Since national income is equal to national output, the increase in the national
income of Singapore due to the increase in the aggregate demand will lead to a rise
in the demand for labour resulting in a fall in unemployment, assuming the size of
the labour force remains the same.
An increase in the investment expenditure in Singapore will lead to a more
rapid increase in the aggregate supply in the long run. When the investment
expenditure in Singapore rises, the production capacity will rise more rapidly in the long
run, assuming the net investment is initially positive. Therefore, the aggregate supply in
Singapore will rise more rapidly in the long run. Aggregate supply is the total supply of
goods and services in the economy over a period of time. When this happens, assuming
the aggregate demand in Singapore is rising, which is the normal state of the Singapore
economy, the national income will rise more rapidly, unemployment will be lower and
the general price level will rise less rapidly.
Although an increase in the investment expenditure in Singapore can be
desirable for the economy, it can also be undesirable.
The increase in the aggregate demand in Singapore will lead to a shortage of
goods and services and hence a rise in the general price level. In the above diagram,
an increase in aggregate demand (AD) from AD0 to AD1 leads to a rise in the general
price level (P) from P0 to P1. This is especially undesirable if the Singapore economy is
over-heating.
The increase in the national income and the general price level in Singapore
will lead to a deterioration in the balance of payments. When the national income in
Singapore rises, the imports will rise. Further, the rise in the general price level will make
Singapore’s goods and services relatively more expensive than foreign goods and
services resulting in a decrease in the net exports. Therefore, the current account and
hence the balance of payments of Singapore will deteriorate.
If the increase in investment expenditure in Singapore is due to an increase
in inward foreign direct investments, outward profit remittances will increase in the
long run which will cause the current account and hence the balance of payments to
deteriorate.
In the final analysis, an increase in the investment expenditure in Singapore is
likely to bring about more benefits than costs to the economy. An increase in the
investment expenditure in Singapore will lead to higher economic growth both in the
short run and in the long run. Although inflation in Singapore will be higher in the short
run, it will be lower in the long run. However, due to several factors such as the
emergence of several developing economies with lower labour cost as manufacturing
powerhouses, any increase in the investment expenditure in Singapore is likely to be
small. Further, investment expenditure is a small component of aggregate demand in
Singapore. Therefore, the effect of an increase in investment expenditure on aggregate
demand is likely to be small in Singapore.