from the additional unit of capital asset. Meaning of Marginal Efficiency of Capital (MEC) is the rate of discount which makes the discounted present value of expected income stream equal to the cost of capital. MEC depends on two factors: . The prospective yield from a capital asset.
. The supply price of a capital asset. Factors Affecting MEC: The marginal efficiency of capital is influenced by short - run as well as long- run factors. These factors are discussed in brief: l The cost of the capital asset l The expected rate of return from during its lifetime l The market rate of interest MEC Three factors that are taken into consideration while making any investment decision a) Short - Run Factors (i) Demand for the product: If the market for a particular good is expected to grow and its costs are likely to fall, the rate of return from investment will be high.
If entrepreneurs expect a fall in demand for goods and a rise in cost, the investment will decline. (ii) Liquid assets: If the entrepreneurs are holding large volume of working capital, they can take advantage of the investment opportunities that come in their way. The MEC will be high. (iii) Sudden changes in income: The MEC is also influenced by sudden changes in income of the entrepreneurs.
If the business community gets windfall profits, or tax concession the MEC will be high and hence investment in the country will go up. On the other hand, MEC falls with the decrease in income. (iv) Current rate of investment: Another factor which influences MEC is the current rate of investment in a particular industry. If in a particular industry, much investment has already taken place and the rate of investment currently going on in that industry is also very large, then the marginal efficiency of capital will be low.
(v) Waves of optimism and pessimism: The marginal efficiency of capital is also affected by waves of optimism and pessimism in the business cycle. If businessmen are optimistic about future, the MEC will be likely