Previous Year Question

An increase in the Expected Return on New Capital is likely to increase private investment. The major motive for investment in the private sector is earning profit. If a new machine, factory or other capital asset is expected to generate greater income or profit in the future, investment in that asset becomes more attractive to entrepreneurs. Economics material on the Government-supported higher-education platform INFLIBNET also states that expected profitability is a major motive behind private-sector investment decisions.

An investment decision is not based only on expected returns; entrepreneurs compare the expected return from capital with the cost of financing the investment, particularly the rate of interest. Keynes explained this relationship through the concept of the Marginal Efficiency of Capital (MEC). When the expected return on capital becomes more attractive relative to the cost of investment, the incentive to undertake new investment increases.

Therefore, an important relationship to remember is: Expected profitability rises → tendency for private investment rises. In contrast, other things being equal, an increase in the rate of interest raises the financing cost of investment and may discourage investment. Since the question specifically asks which increase is more likely to increase private investment, the most appropriate option is the Expected Return on New Capital.