THEKEYNESI
ANTHEORYOFI
NVESTMENT
Accordi
ngt otheclassicalt
heoryt herearet hr
eedet er
minantsof
busi
ness investment,viz.
,( i
)cost ,(ii
)r et
urn and (ii
i)expect
ati
ons.
AccordingtoKey nesinv
estmentdeci sionsaret akenbycompar ingthe
marginaleffi
ciencyofcapital(MEC)ort hey i
eldwi ththerealrat
eof
i
nterest(r
).
Sol ongastheMECi sgreaterthanr,newi nvest
mentinplant
,
equi
pmentandmachi ner
ywi llt
akeplace.
Howev er
,asmor eandmorecapitali
susedi ntheproduct
ionpr ocess,
theMECwi l
lfal
lduetodimi
nishi
ngmar gi
nalpr
oductofcapit
al.Assoon
asMECi sequatedtor,nonewinvest
mentwi l
lbemadei nanyi ncome-
earni
ngasset
.
Mar
ginal
Eff
ici
encyofCapi
tal
:
TheMECi sther at
eofdiscountwhi chequatesthepresentval
ueofa
ser
iesofcashf l
owsobt ainablefr
om ani ncome-ear
ningassetlikea
machineoverit
sent i
reeconomi cl
if
et othecostoft hemachine.The
MECistherateofret
urnatwhi chaproj
ectisexpect
edtobreak¬even.
Thisdependsont heimmediat
eprofi
ts(
cashf l
ows)expect
ed fr
om
operat
ingthepr oj
ectandt
herateatwhi
cht
heseareexpect
edtodecl
ine
thr
oughr educt
ioninthepr
iceofout
put,
ori
ncr
easesinther
ealwagesor
costofrawmat eri
alsandf
uel.
Ifallpossibleprojectsi
naneconomyar earr
angedindescendi
ngorder
oft heirMEC,i nvestorswillacceptthosewi t
hMEChi gherthanrand
rej
ectt hosewhoseMECi slowerthanr.TheMECi snotthesameast he
mar ginalproductofcapitalwhichisconcernedonl
ywiththeimmediate
effectofaddi t
ionalcapit
alonpossibl
eout putandnotwit
hhowl ongthe
resulti
ngpr of
it
scanbeexpect edtopersist
.
TheMEC i sther at
eofr et
urn( profi
ts)onanext rarupeewor t
hof
i
nvestment.Themar ginaleff
ici
encyofcapi t
aldecreasesast heamount
of inv
estmenti ncreases.Thisi s because ini
tialinvest
ments are
concentr
atedont he‘best’opport
uni t
iesandy i
eldhighratesofretur
n;
, l
aterinvest
ment
sar
elesspr
oduct
iveandsecur
epr
ogr
essi
vel
ylower
r
eturns.
Theamountofi nvestmentundertakendependsnotonl yonexpect ed
ret
urns butalso on t he costofcapi tal
,t hati s,the i
nter
estr ate.
Inv
estmentwi llbe pr of
it
able up tot he poi ntwher ethe mar ginal
eff
ici
encyofcapitali
sequalt ot
hecostofcapi tal
.Inthefol
l
owingf i
gure
ataninter
estrateof20%onl y0I0amountofi nv est
mentiswor t
hwhile.A
fal
lint he i
nter
estr ateto 10% increases t he amountofpr of
it
able
i
nvestment0I1.
I
twi l
lber eadil
yapparentf
rom t
hefi
guret
hatther
eisalinkbet
weent he
monet arysideoft heeconomyandtherealeconomyaf al
linint
erest
rateswi l
lstimulat
emor einv
estment
,whi
ch,initstur
n,wil
lresul
tina
higherlevelofnati
onali
ncome.
Ifexpect ati
onschangeandi nvestorsexpectt or eceivebett
erret
urns
from each i nvestment — because,f or exampl e,of technol
ogi
cal
progress — t hen atanygi ven rate ofi nterestsuch as 20%)mor e
i
nv estmentwi llbe under taken than bef ore;t hati s,the margi
nal
effi
ciencyofcapi talschedulewi l
lshifttot her ight,asshowni nFig.
18.1(b),andinvest mentwil
lincreasefrom OI2t oOI0.
TheMECi scalculatedbyusingt hefol
lowingf ormul a:
ANTHEORYOFI
NVESTMENT
Accordi
ngt otheclassicalt
heoryt herearet hr
eedet er
minantsof
busi
ness investment,viz.
,( i
)cost ,(ii
)r et
urn and (ii
i)expect
ati
ons.
AccordingtoKey nesinv
estmentdeci sionsaret akenbycompar ingthe
marginaleffi
ciencyofcapital(MEC)ort hey i
eldwi ththerealrat
eof
i
nterest(r
).
Sol ongastheMECi sgreaterthanr,newi nvest
mentinplant
,
equi
pmentandmachi ner
ywi llt
akeplace.
Howev er
,asmor eandmorecapitali
susedi ntheproduct
ionpr ocess,
theMECwi l
lfal
lduetodimi
nishi
ngmar gi
nalpr
oductofcapit
al.Assoon
asMECi sequatedtor,nonewinvest
mentwi l
lbemadei nanyi ncome-
earni
ngasset
.
Mar
ginal
Eff
ici
encyofCapi
tal
:
TheMECi sther at
eofdiscountwhi chequatesthepresentval
ueofa
ser
iesofcashf l
owsobt ainablefr
om ani ncome-ear
ningassetlikea
machineoverit
sent i
reeconomi cl
if
et othecostoft hemachine.The
MECistherateofret
urnatwhi chaproj
ectisexpect
edtobreak¬even.
Thisdependsont heimmediat
eprofi
ts(
cashf l
ows)expect
ed fr
om
operat
ingthepr oj
ectandt
herateatwhi
cht
heseareexpect
edtodecl
ine
thr
oughr educt
ioninthepr
iceofout
put,
ori
ncr
easesinther
ealwagesor
costofrawmat eri
alsandf
uel.
Ifallpossibleprojectsi
naneconomyar earr
angedindescendi
ngorder
oft heirMEC,i nvestorswillacceptthosewi t
hMEChi gherthanrand
rej
ectt hosewhoseMECi slowerthanr.TheMECi snotthesameast he
mar ginalproductofcapitalwhichisconcernedonl
ywiththeimmediate
effectofaddi t
ionalcapit
alonpossibl
eout putandnotwit
hhowl ongthe
resulti
ngpr of
it
scanbeexpect edtopersist
.
TheMEC i sther at
eofr et
urn( profi
ts)onanext rarupeewor t
hof
i
nvestment.Themar ginaleff
ici
encyofcapi t
aldecreasesast heamount
of inv
estmenti ncreases.Thisi s because ini
tialinvest
ments are
concentr
atedont he‘best’opport
uni t
iesandy i
eldhighratesofretur
n;
, l
aterinvest
ment
sar
elesspr
oduct
iveandsecur
epr
ogr
essi
vel
ylower
r
eturns.
Theamountofi nvestmentundertakendependsnotonl yonexpect ed
ret
urns butalso on t he costofcapi tal
,t hati s,the i
nter
estr ate.
Inv
estmentwi llbe pr of
it
able up tot he poi ntwher ethe mar ginal
eff
ici
encyofcapitali
sequalt ot
hecostofcapi tal
.Inthefol
l
owingf i
gure
ataninter
estrateof20%onl y0I0amountofi nv est
mentiswor t
hwhile.A
fal
lint he i
nter
estr ateto 10% increases t he amountofpr of
it
able
i
nvestment0I1.
I
twi l
lber eadil
yapparentf
rom t
hefi
guret
hatther
eisalinkbet
weent he
monet arysideoft heeconomyandtherealeconomyaf al
linint
erest
rateswi l
lstimulat
emor einv
estment
,whi
ch,initstur
n,wil
lresul
tina
higherlevelofnati
onali
ncome.
Ifexpect ati
onschangeandi nvestorsexpectt or eceivebett
erret
urns
from each i nvestment — because,f or exampl e,of technol
ogi
cal
progress — t hen atanygi ven rate ofi nterestsuch as 20%)mor e
i
nv estmentwi llbe under taken than bef ore;t hati s,the margi
nal
effi
ciencyofcapi talschedulewi l
lshifttot her ight,asshowni nFig.
18.1(b),andinvest mentwil
lincreasefrom OI2t oOI0.
TheMECi scalculatedbyusingt hefol
lowingf ormul a:
