expectations and profits are more important in deciding investment. He also pointed out that investment depends on MEC (Marginal Efficiency of Capital) and rate of interest. i. Private investment is an increase in the capital stock such as buying a factory or machine.
ii. The marginal efficiency of capital (MEC) states the rate of return on an investment project. Specifically, it refers to the annual percentage yield (output) earned by the last additional unit of capital. iii.
If the marginal efficiency of capital is % and interest rates is %, then it is worth borrowing at % to get an expected increase in output of %. . . .
Relationship between rate of interest and Investment: An explanation of how the rate of interest influences the level of investment in the economy. Typically, higher interest rates reduce investment, because higher rates increase the cost of borrowing and require investment to have a higher rate of return to be profitable. Interest rates and investment As the real cost of borrowing rises, fewer investment projects are profitable. If interest rates rise from % to %, then we get a fall in the amount of investment from ₹ cr to ₹ cr.
If interest rates are increased then it will tend to discourage investment because investment has a higher opportunity cost. . With higher rates, it is more expensive to borrow money from a bank. .
Saving money in a bank gives a higher rate of return. Therefore, using savings to finance investment has an opportunity cost of lower interest payments. % % Amount (Volume) of Investment Interest Rate % y x Figure. .
- - Consumption and Investment Functions If interest rates rise, firms will need to gain a better rate of return to justify the cost of borrowing using savings. . . .
Marginal Efficiency of Capital. MEC was first introduced by J.M Keynes in as an important determinant of autonomous investment. The MEC is the expected profitability of an additional capital asset. It may be defined as the highest rate of return over cost expected