Marginal Efficiency of Capital | Factors affecting Marginal Efficiency of Capital

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Hi friends, in today’s article we are going to know about the concept of Marginal Efficiency of Capital (MEC) and also know the factors which affecting marginal efficiency of capital. So let’s discuss in details.

What is Marginal Efficiency of Capital?

The Marginal Efficiency of Capital or MEC 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.

Factors affecting Marginal Efficiency of Capital

The marginal efficiency of capital is influenced by the short run as well as long run factors. These factors are discussed in the following ground-

Short Run Factors affecting MEC

• Expected Demand for the Products – If the demand for the products is expected to be high in future the marginal efficiency of capital will be high and the investment will increase.

On the other hand, if the demand for the products is expected to be decline in future, the MEC and demand for investment will be fall.

Expected Price and Cost of Products – If the costs are expected to decline and its price are expected to increase the expectations of the products will go up. On the other hand, if the cost are expected to go up and the price are to decline, the marginal efficiency of capital will receive a set back and the investment will be less.

• Propensity to Consume – It is important to point out that demand for investment or demand for capital goods is derived from demand for consumer goods. If propensity to consume rises, it will cause favourable shift in investment demand.

• Current rate of Investment – If in a particular industry much investment has already taken place and the rate of investment currently going on its that industry is also very large the marginal efficiency of capital will be low.

• Sudden Change in Income – The MEC is also influenced by changes in income. An increase in the level of income will encourage investment and the marginal efficiency of capital will also increase. On the other hand, a decrease in income discourage the investment.

Long Run Factors affecting MEC

• Growth rate of Population – If rate of growth of population is high, it causes the general demand level in the economy to rise because rapidly growing population implies rapid increase in requirements of all types of goods and services both consumption goods and investment goods. Rise in demand will rise in MEC.

• Technological Advancement – If there is improvement in technology like development of new method of production, investment of new machines, etc. it affects MEC favourable and leads to rise in MEC and investment demand.

• Rate of Taxes – Marginal efficiency of capital is directly influenced by the rate of taxes levied by the govt. on various commodities, when taxes are imposed, the cost of commodities is increased and the revenue is lowered when profits are reduced MEC will be low.

• Foreign Trade – Existing level of foreign trade and the prospects for expectation of international trade increase the demand for more investment and shifts the investment demand function upward.

• Developments of New areas – The growth and developments of new areas requires heavy investment in different fields such as additional transport, electricity, irrigation facilities, agriculture facilities, etc. Thus MEC and investment demand go up.

Distinguish between Marginal Efficiency of Capital (MEC) and MEI

A.P Lerner points out that what Keynes calls marginal efficiency of capital is in fact marginal efficiency of investment and such as there is not much difference between the two concept. However, the main points of the difference between MEC and MEI can be stated as follows –

(i) The MEC is based on given supply price for capital and the MEI is based on induced changes in prices.

(ii) The MEC shows the rate of return on all successive units of capital without regard to the existing stock of capital. On the other hand, the MEI shows the rate of return on only units of capital over and above the existing stock of capital.

(iii) The MEC is a stock concept but the MEI is a flow concept.

(iv) In the MEC, the capital stock is taken on the horizontal axis at a diagram, but in the MEI the amount of investment is taken horizontally the X axis in the figure.

(v) The marginal efficiency of capital determines the optimum capital stock in an economy at which level of interest rate, the MEI determined the net investment of the economy at each interest rate given the capital stock.

Conclusion

So friends, this was the concept of Marginal Efficiency of Capital. Hope you get the full details about it and hope you like this article.

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