MARGINAL EFFICIENCY OF CAPITAL

by • 02/07/2011 • B.COM PART 1 EconomicsComments (0)1060

The marginal efficiency of capital is the rate of return on the last unit of capital employed. Investment depends upon rate of interest and MEC, which is also called rate of profit. If the MEC is greater than or at least equal to the rate of interest, then firm will expand the capital stock.

Investment

MEC Rate of Profit

Rate Of Interest

OX

20%

20%

OY

15%

15%

OZ

10%

10%

When investment increases from OX to OY, prices decreases because more goods are supplied, this reduces the profit margin. The MEC decreases from 20% to 10%. At an interest rate of 20%, only OX investment is worthwhile. A fall in the interest rate to 10% increases the amount to OZ.

It means a fall in interest rates will stimulate more investment, which in turn will result in a higher level of national income.

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