Saturday, February 23, 2013

The Marginal Efficiency of Capital

"More precisely, I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price..

"Now it is obvious that the actual rate of current investment will be pushed to the point where there is no longer any class of capital-asset of which the marginal efficiency exceeds the current rate of interest. In other words, the rate of investment will be pushed to the point on the investment demand-schedule where the marginal efficiency of capital in general is equal to the market rate of interest..

"There is, to begin with, the ambiguity whether we are concerned with the increment of physical product per unit of time due to the employment of one more physical unit of capital, or with the increment of value due to the employment of one more value unit of capital. The former involves difficulties as to the definition of the physical unit of capital, which I believe to be both insoluble and unnecessary. It is, of course, possible to say that ten labourers will raise more wheat from a given area when they are in a position to make use of certain additional machines; but I know no means of reducing this to an intelligible arithmetical ratio which does not bring in values. Nevertheless many discussions of this subject seem to be mainly concerned with the physical productivity of capital in some sense, though the writers fail to make themselves clear."-- Keynes, The General Theory, Chapter 11

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