The marginal efficiency of capital (MEC) is that rate of discount which would equate the price of a fixed capital

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

with its present discounted value of expected income. The term “marginal efficiency of capital” was introduced by

John Maynard Keynes John Maynard Keynes, 1st Baron Keynes ( ; 5 June 1883 – 21 April 1946), was an English economist and philosopher whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originall ...

in his '' General Theory'', and defined as “the rate of discount which would make the

present value In economics and finance, present value (PV), also known as present discounted value (PDV), is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money ha ...

of the series of annuities given by the returns expected from the

capital asset A capital asset is defined as property of any kind held by an assessee. It need not be connected to the assesse’s business or profession. The term encompasses all kinds of property, movable or immovable, tangible or intangible, fixed or circula ...

during its life just equal its supply price”.Keynes, John Maynard; ''The General Theory of Employment, Interest, and Money'' (1936), p 135. 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 In accountancy, depreciation refers to two aspects of the same concept: first, an actual reduction in the fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation i ...

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 rate of interest, ''r'', for investment to take place. This is because the present value PV of future returns to capital needs to be higher than the cost of capital, C_k. These variables can be expressed as follows: *

PV =\sum_^n \frac,

where ''n'' is the number of years during which the capital will be productive, and ''R''_''i'' is the net return in year ''i''; *

C_k =\sum_^n\frac,

where ''C''_''k'' is the upfront capital outlays; this equation defines the MEC. Hence, for investment to take place, it is necessary that PV > C_k; 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

European Commission The European Commission (EC) is the primary Executive (government), executive arm of the European Union (EU). It operates as a cabinet government, with a number of European Commissioner, members of the Commission (directorial system, informall ...

according to its data bank "AMECO" (Annual Macro-Economic Data) the marginal efficiency of capital is defined as "Change in GDP at constant market prices of year T per unit of gross fixed capital formation at constant prices of year T − 0.5 hat is, lagged by half a year"Marginal Efficiency of Capital" in Ameco
/ref> MEoC

References

Economic efficiency Keynesian economics Marginal concepts {{Econ-theory-stub

See also

References