According To J M Keynes The Volume Of New Investment Depends On The Following Two Factors (1) Marginal Efficiency Of Capital Mec (2) Market Rate Of Interest The Producers Decision As To Whether Or Not He Should Undertake A Given Investment Project Is Arrived At By Comparing Marginal Efficiency Of Capital (Mec) With The Market Rate Of Interest (Or The Cost Of Funds)
Meaning Of Marginal Efficiency Of Capital The Marginal Efficiency Of Capital Is The Expected Annual Rate Of Return On An Additional Unit Of A Capital Good It Is Also Described As The Rate Of Return Expected To Be Received On Money If It Were Invested In A Newly Produced Asset According To Keynes The Marginal Efficiency Of Capital Is The Rate Of Discount V H Makes The Present Value Of The Prospective Yield From The Catifq Set Equal To Its Supply Price The Marginal Efficiency Of Capital Will Progressively As Investment In The Asset Increases The Marginal Efficiency Of Capital (Mec) Curve Is Therefore Negatively Sloped
Factors affecting MEC
The Marginal Efficiency Of Capital Is Influenced By Short Run As Well As Long Run Factors These Factors Are Now Discussed In Brief
(A) Short Run Factors
(1) Demand for the product. If The Market For A Particular Good Is Expected To Grow And Its Costs Are Likely To Fall The Rate Of Return From Investment Will Be High If Entrepreneurs Expect A Fall In Demand Of Goods And A Rise In Cost The Mec Will Decline
(2) Liquid assets. If The Entrepreneurs Are Holding Large Volume Of Working Capital They Can Take Advantage Of The Investment Opportunities That Come In Their Way The Mec Will Be High And Vice Versa
Sudden changes in income. The Mec Is Also Influenced By Sudden Changes In Income Of The Entrepreneurs If The Business Community Gets Windfall Profits Or There Are Tax Concessions Etc The Mec Will Be High And Hence Investment In The Country Will Go Up On The Other Hand Mec Falls With The Decrease In Income
(4) Current rate of investment. Another Factor Which Influences Mec Is The Current Date Of Investment In A Particular Industry If In A Particular Industry Much Investment Has Already Taken Place And The Rate Of Investment Currently Going On In That Industry Is Also Very Large Then The Marginal Efficiency Of Capital Will Be Low
(5) Wave of optimism and pessimism. The Marginal Efficiency Of Capital Is Also Affected By Waves Of Optimism And Pessimism In The Business Circle If Businessmen Are Optimistic About Future The Mec Will Be Overestimated During Periods Of Pessimism The Mec Is Under Estimated
(B) Long Run Factors The Long Run Factors Which Influence The Marginal Efficiency Of Capital Are As Under.
(6) Rate of Growth of Population: Marginal Efficiency Of Capital Is Also Influenced By The Rate Of Growth Of Population If Population Is Growing At A Rapid Speed It Is Usually Believed That The Demand Of Various Classes Of Goods Will Increase So A Rapid Rise In The Growth Of Population Will Increase The Marginal Efficiency Of Capital And A Slowing Down In Its Rate Of Growth Will Discourage Investment And Thus Reduce Marginal Efficiency Ofcapital
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