Page 117 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes Figure 6.6

The more elastic the MEC schedule, the greater will be the increase in investment in response to
a given fall in the rate of interest. Keynes found that fluctuation in investment is mainly due to
fluctuation in MEC. In the short run, the rate of interest is given, thus the more important
determinant of investment is MEC. However, MEC is essentially dependent on future expectation
regarding the prospective yield and life span of the capital asset. Since MEC is, to some extent,
a psychological phenomenon, it is influenced by expectation.

Notes In fact the MEC curve can be taken to show the firm's demand curve for capital.
It shows the amount of capital that a firm would choose to employ at different costs of
employing, i.e., different rates of interest. The equilibrium amount of capital of a profit
making firm is that at which MEC is exactly equal to rate of interest. Similarly, by adding
the MEC schedules of individual firms, we arrive at the MEC schedule of society or an
economy. So like the downward sloping MEC schedule of a firm the MEC schedule for the
economy as a whole is also downward sloping.

6.2.3 The Cost and Productivity of Capital Goods

Like the cost of funds needed for investment expenditure, the price and productivity of machines
being purchased have an influence on the profitability of investment.
A new process that reduces the price of capital goods will make any given line of investment
more profitable because the interest costs involved will be reduced.

Example: A duplicating machine of 120,000 will have an interest cost of 12,000 per
year at a rate of 10%, but if the price falls to 80,000, its interest cost will be only 8,000.

Moreover, any new invention that makes capital equipment more productive will make
investment more attractive, for example, if the replacement of typewriters by word-processors
makes a given amount spent on office equipment more productive, this will lead to a burst of
investment expenditure to obtain the new capital equipment.

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