Concept Of Marginal Efficiency Of Capital (MEC) Marginal efficiency of capital (for marginal efficiency of investment) Marginal efficiency of capital (MEC) is a Keynesian concept. According to J. M. Keynes, nations output depends on its stock of capital. An increase in the stock of capital increases output. The question is how much increase in investment raises output’? Well, this depends on the productivity of new capital i.e. on the marginal efficiency of capital. Marginal efficiency of capital is the rate of return expected to be obtainable on a new capital asset over its life time. J. M. Keynes defines marginal efficiency of capital as “the rate of discount which makes the present value of the prospective yield from the capital asset equal to its supply price” A businessman while investing in a new capital asset, examines the expected fate of net return (profit) on it during its lifetime against the supply price of capital asset (cost of capital asset) if the expected rate of profit is greater than the replacement cost of the asset. the businessman will invest the money in the project. For example, if a businessman spends Rs. 10,000 on the purchase of a new griding machine We assume further that this new capital asset continues to produce goods over a long period of time The net return (excluding meeting all expenses except the interest cost) of the griding machine is expected to be Rs. 1000 per annum. The marginal efficiency of capital will be 10%. 1000 100 10000 – 10%. The following formula is used to know the present value of series of expected income throughout the life span of the capital assets. 1 R2 P 1+r l+r 1-1-r S, = stands for supply price of the new capital asset i 2 Rn = stands for returns received on yearly basis. R = It is the rate of discount applied in each of the years Schedule of marginal efficiency of capital According to J. M. Keynes, the behaviour of investors in respect of new investment depends upon the various stocks of capital available in the economy at a particular period of time As the stock of capital increases in the economy, the marginal efficiency of capital goes on diminishing. The MEC curve is negatively sloped as is shown in the figure 30.7. Investment (Rs. billion) Marginal efficiency of capital 20 10% . 25 9% 40 7% 70 5% 100 2% ‘ In the above table, it is shown when stock of capital is equal to Rs. 20 billion, the marginal efficiency of capital is 10%. while at a capital stock of Rs 100 billion, it declines to 2%. This investment demand schedule when depicted graphically in figure 30.7 gives us the investment demand curve which goes on sloping downward from left to right. Relative role of MEC and the rate of interest. The MEC and the rate of interest are the two important factors which affect the volume of new investment in a country. An investor while making a new investment, weighs the MEC of new investment against the prevailing rate of interest As long as the MEC is higher than the rate of interest, the investment will be made till the MEC and the rate of interest are equalized For example, if the rate of interest is 7%, the induced investment will continue to be made till the MEC and the rate of interest are equalized. At 7% rate of interest, the new investment will be Rs. 40 billion. In case, the rate of interest comes down to 2%, the new investment in capital assets will be Rs. 100 billion. Summing up, if investment is to be increased in the country. either the rate of interest should go down or MEC should increase. The investment demand function is expressed as under. I = f(i, r), where i = investment demand, i = Rate of interest and r = expected rate of return or MEC. Related Economics Topics Factors On Which Marginal Efficiency Of Capital Depends Criticism of Keynes theory of interest The Actual Growth Rate (Saving = Investment) Neo-Classical Model And Fiscal Policy The Concept Of Investment (investment function) This entry was posted in Economics and tagged Concept Of Marginal Efficiency Of Capital (MEC), Determinants Or The Level Or National Income And Employment, Economics. Bookmark the permalink. Possible Questions from this Topic : 1- What is Concept Of Marginal Efficiency Of Capital (MEC)? 2- Why is Concept Of Marginal Efficiency Of Capital (MEC)? 3- Where is Concept Of Marginal Efficiency Of Capital (MEC) used in Economics ? 4- Explain the theory of Concept Of Marginal Efficiency Of Capital (MEC) ? You can find the Answers in the article above. (Questions written above are auto generated so English grammatical or structural errors are
Posted on: Sat, 15 Mar 2014 07:45:17 +0000
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