Marginal efficiency of capital
The marginal efficiency of capital (MEC) is that rate of discount which would equate the price of a fixed capital asset with its present discounted value of expected income.
The term “marginal efficiency of capital” was introduced by
The MEC is the net rate of return that is expected from the purchase of additional capital. It is calculated as the profit that a firm is expected to earn considering the cost of inputs and the depreciation of capital. It is influenced by expectations about future input costs and demand. The MEC and capital outlays are the elements that a firm takes into account when deciding about an investment project.
The MEC needs to be higher than the
- where n is the number of years during which the capital will be productive, and Ri is the net return in year i;
- where Ck is the upfront capital outlays; this equation defines the MEC.
Hence, for investment to take place, it is necessary that PV > Ck; that is, MEC > r. As a consequence, an inverse relationship between the rate of interest and investment is found (i.e.: a higher rate of interest generates less investment).
With the
See also
- Capital good
- Internal rate of return
- Marginalism
- Marginal concepts
References
- ^ Keynes, John Maynard; The General Theory of Employment, Interest, and Money (1936), p 135.
- ^ "Marginal Efficiency of Capital" in Ameco