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1. The Marginal Efficiency of Capital “The marginal efficiency of capital is equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital asset during its life just equal to its supply price.” – J.M.Keynes, General Theory

2. MEC MarginalEfficiencyofcapital The Stock of Capital C As the stock of capital increases , the marginal efficiency of capital is likely to decrease (law of diminishing marginal returns)

3. Marginal Efficiency of Capital The MEC curve is plotted by graphing the return from each additional unit of capital. The MEC curve links the rate of return to the desired stock of capital, at a given moment in time.

4. Net Productivity The output attributable to capital is known as net productivity. The marginal physical product achieved from additional capital is calculated by measuring output as a % of the rate of return Marginal Efficiency of Capital – The Rate of return on the last unit of capital employed

5. Theory of Marginal Efficiency of Capital The theory of marginal efficiency indicates that investment decisions will be influenced by: • The marginal efficiency of capital • The interest rates

6. Marginal Efficiency of Capital Cost of Capital Demand for goods Marginal rate of Tax Availability of Finance Expectations and confidence Technological Innovation Factors Affecting the Marginal Efficiency of Capital

7. Factors Affecting the Marginal Efficiency of Capital 1. The cost of capital. If cheap capital is available for investment, then investment opportunities become more attractive.

8. MEC MEC I1 I2 R1 R2 Rate of Interest Investment A reduction in the rate of interest is likely to increase the marginal efficiency of capital, resulting in an increase in the marginal efficiency of capital

9. Factors Affecting the Marginal Efficiency of Capital 2. Demand for goods and services If tastes and preferences change and demand for a good increases, then the increased demand is likely to increase profitability.

10. Factors Affecting the Marginal Efficiency of Capital 3. The marginal rate of tax If the marginal rate of tax is increased then the net return on an investment will fall, reducing the marginal efficiency of capital. 4. The availability of finance Restrictions on lending will limit investment. A relaxation of credit controls will make investment easier.

11. Factors Affecting the Marginal Efficiency of Capital 5. Expectations and confidence If people believe that growth in economy is slowing and unemployment may rise in the foreseeable future, then demand in the economy may contract. In addition, if business confidence is low, then firms are less likely to invest in increased capacity and new product development. 6. Technological change Innovation in products or processes may increase the potential size of the market or help to drive down costs.