Factors Affecting marginal Efficiency of Capital

There are a large number of long-run and short-run factors affecting MEC which are explained as follows:

  • Short-run Factors:

            There are large numbers of short-run factors which influence MEC. Among the short-run affecting factors of MEC, the following are important.

(1) Nature of demand, prices and cost:

If the costs are expected to rise or prices are likely to fall and the demand for a particular product is going declining in future, average businessman’s expectations regarding the rate of return (MEC) from any given investment will also decline, affecting the investment adversely.

(2) Propensity to consume:

Favorable short-run shifts in the propensity to consume also cause favorable shifts in investment because the demand for capital goods is at least partly derived from the demand for consumer goods.

(3) Change in liquid assets:

            The amount of liquid assets with the investors also influences the MEC or investment. If they possess large liquid assets, the investment is high. This is especially the case with those firms which keep large reserve funds and undistributed profits.

(4) Change in income:

            If the level of income rises in the economy through rise in money wage rates and other factor prices, the demand for goods will rise which will, in turn, raise the investment.

(5) Element of Uncertainty:

According to Keynes, the MEC is more important than the rate of interest. This is because the prospective yield of capital assets depends upon the business expectations. These business expectations are very uncertain which may reduce investment.


  • Long-run Factors:

Following are the important factors which affect the marginal efficiency of capital in the long-run:

(1) Population growth Rate:

            A rapidly growing population means a growing market for all types of goods in the economy. To meet the demand of an increasing population, investment will increase in all types of consumer goods industries. On the other hand, a declining population results in a shrinking market for goods thereby lowering the investment.

(2) New product:

            The nature of new products in terms sales and costs may also influence their MEC and hence investment. If the sale prospects of a new product are high and the expected revenues more than the costs, the MEC will be high which will encourage to invest.

(3) Inventions and Innovations:

            Inventions and innovations tend to raise the inducement to invest. If inventions and technological improvements lead to more efficient methods of production which reduce costs, the MEC of new capital assets will rise. Higher MEC will induce firms to make larger investments in the new capital assets.

(4) Political climate:

Political conditions also affect the inducement to invest. If there is political instability in the country, the MEC may be affected adversely. In the struggle for power, the rival parties may create unrest through hostile trade union activities thus creating uncertainty in business. On the other hand, a stable government creates confidence in the business community whereby the investment is raised.

(5) State policy:

            The economic policies of the government have an important influence on the MEC or investment in the country. If the government imposes heavy progressive taxes on corporations, the investment is low, and vice-versa. If the state follows the policy of nationalization of industries, the private enterprise would be discouraged to invest. On the other hand, if the state encourages private enterprise by providing credit, power and other facilities, investment will be high.

One thought on “Factors Affecting marginal Efficiency of Capital”

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