Class 12 Macroeconomics Chapter 4 |Determinants of Investment 2022-23
Summary
TLDRThe video script discusses John Maynard Keynes' theory on private investment decisions, focusing on the Marginal Efficiency of Investment (MEI) and the Rate of Interest. MEI is the expected return from an additional investment, influenced by the cost of producing a new asset (supply price) and the net return over its lifetime. The Rate of Interest (ROI) is the cost of borrowing money for investment. An inverse relationship exists between ROI and investment volume; if MEI exceeds ROI, the investment is considered profitable. The script uses an example of a machine investment to illustrate the calculation of MEI and the decision-making process based on ROI.
Takeaways
- 💡 Keynesian Economics: The decision to invest in a new project is influenced by two key factors: the marginal efficiency of investment (MEI) and the rate of interest (ROI).
- 📈 Marginal Efficiency of Investment (MEI): This is the expected rate of return from an additional investment and is determined by the supply price and the prospective yield.
- 💼 Supply Price: Refers to the cost of producing a new asset or the price at which the new capital asset can be supplied or replaced.
- 🌱 Prospective Yield: Represents the net return expected from the capital asset over its lifetime, calculated by subtracting running expenses from the expected receipts.
- 🔢 MEI Calculation: The formula for calculating MEI involves the prospective yield divided by the supply price, multiplied by 100.
- 📊 Rate of Interest (ROI): This is the cost of borrowing money to finance the investment and has an inverse relationship with the volume of investment.
- 🔗 Inverse Relationship: There is an inverse relationship between ROI and the volume of investment, meaning higher interest rates can deter investment.
- 💰 Profitability Assessment: The profitability of an investment can be assessed by comparing MEI with ROI. If MEI is greater than ROI, the investment is considered profitable.
- 📚 Example Given: An entrepreneur who pays a 12% ROI on a loan and expects an MEI of 20% is in a profitable situation, as the expected return from the investment exceeds the cost of borrowing.
- 🏢 Investment Decision: Private investment decisions are based on the comparison between the marginal efficiency of investment and the rate of interest, guiding whether or not to proceed with a project.
Q & A
What does Keynesian theory suggest about the decision to invest in a new project?
-According to Keynes, the decision to invest in a new project depends on the marginal efficiency of investment (MEI) and the rate of interest. MEI is the expected rate of return from an additional investment, and the rate of interest is the cost of borrowing money for financing the investment.
What is the marginal efficiency of investment (MEI)?
-MEI refers to the expected rate of return from an additional investment. It is determined by the supply price, which is the cost of producing a new asset, and the net return expected from the capital asset over its lifetime.
How is the supply price defined in the context of MEI?
-The supply price is the cost at which a new capital asset can be supplied or replaced. For instance, if a machine costs $10,000 to replace an old one, then $10,000 is the supply price.
What is the role of the net return in calculating MEI?
-The net return is the prospective yield from an investment, calculated by subtracting the running expenses from the expected receipts and then dividing by the supply price. This helps in determining the profitability of the investment.
What is the relationship between the rate of interest (ROI) and the volume of investment?
-There is an inverse relationship between ROI and the volume of investment. As the rate of interest increases, the volume of investment tends to decrease, and vice versa.
How can the profitability of an investment be assessed?
-The profitability of an investment can be assessed by comparing MEI with ROI. If MEI is greater than ROI, then the investment is considered profitable.
What is the significance of the rate of interest in the investment decision?
-The rate of interest is significant because it represents the cost of borrowing money for financing the investment. A higher rate of interest can make an investment less attractive, while a lower rate can encourage more investment.
Can you provide an example of how MEI is calculated?
-Sure, if a machine expected to yield receipts of $1,200 and the running expenses are $200, then the prospective yield would be (1200 - 200) / supply price. Multiplying this by 100 gives the percentage rate of return, which is part of calculating MEI.
How does an entrepreneur decide whether to proceed with an investment?
-An entrepreneur decides to proceed with an investment if the expected rate of profit (MEI) is higher than the rate of interest they have to pay on the loan acquired for the investment.
What does an MEI of 20% and a ROI of 12% imply for an entrepreneur?
-If an entrepreneur has to pay a 12% rate of interest on a loan and the expected rate of profit (MEI) is 20%, then the investment is profitable as the MEI is higher than the ROI.
Outlines
💼 Investment Decision Factors
This paragraph discusses the key factors influencing private investment decisions according to Keynesian economics. It emphasizes the importance of the Marginal Efficiency of Investment (MEI), which represents the expected rate of return on an additional investment. The MEI is influenced by two main factors: the supply price, which is the cost of producing or replacing a new asset, and the net return expected from the capital asset over its lifetime, calculated by subtracting running expenses from expected receipts and then dividing by the supply price to get a percentage. The paragraph also introduces the concept of the rate of interest (ROI), which is the cost of borrowing money for investment.
📊 Calculating MEI and ROI
The second paragraph delves deeper into the calculation of MEI and ROI. It explains that MEI is determined by the supply price of a new asset and its prospective yield, which is the net return expected from the investment. The example given illustrates how to calculate the MEI using a machine with a supply price of $10,000 and expected receipts of $1,200, with running expenses of $200. The ROI, on the other hand, is the rate at which money is borrowed for investment and is inversely related to the volume of investment. A higher ROI would typically discourage investment, while a lower ROI would encourage it.
🔗 Relationship Between MEI and ROI
This paragraph explores the inverse relationship between the rate of interest and the volume of investment. It explains that the profitability of an investment can be assessed by comparing the MEI with the ROI. If the MEI is greater than the ROI, the investment is considered profitable. This comparison is crucial for entrepreneurs and investors to make informed decisions about whether to proceed with a project or not.
🏭 Example of Investment Decision Making
In the fourth paragraph, an example is provided to illustrate the concept of investment decision making. An entrepreneur who has to pay a 12 percent rate of interest on a loan is considering an investment with an expected MEI of 20 percent. The example highlights the importance of comparing the cost of borrowing (ROI) with the expected return on investment (MEI) to determine if the investment is worthwhile.
Mindmap
Keywords
💡Keynes
💡Investment
💡Marginal Efficiency of Investment (MEI)
💡Rate of Interest
💡Supply Price
💡Prospective Yield
💡Cost of Producing
💡Profitability
💡Entrepreneur
💡Loan
Highlights
Keynes' theory on private investment decision-making
Marginal Efficiency of Investment (MEI) concept
Factors determining MEI
Supply price as a component of MEI
Example of calculating supply price
Prospective yield in investment calculations
Formula for calculating MEI
Rate of Interest (ROI) as a factor in investment decisions
Inverse relationship between ROI and investment volume
Profitability assessment through MEI and ROI comparison
Decision-making when MEI exceeds ROI
Entrepreneurial investment scenario
Impact of high MEI on investment decisions
Practical application of Keynes' investment theory
Importance of understanding MEI and ROI for investors
Keynes' investment theory in modern economic practice
Transcripts
so according
to keynes the decision to invest in a
new project that
is private investment depends upon two
factors
marginal efficiency of investment and
rate of interest again
yes
so m e i refers to the expected rate of
return
from an additional investment they go
marginal
efficiency of investment up in a
investment
particularly
e i refers to the expected rate of
return
from an additional investment again for
mei is determined by two factors
marginal efficiency of investment a b
though factors
supply
so it refers to the cost of producing a
new asset
of that kind it is the price at which
the new capital asset can be supplied or
replaced supply price supply price
cost of producing a new asset
okay for example
if a machine of 10 000 is replaced
in a place of an old machine then 10 000
is a supply price so
the net return net of all cost expected
from the capital asset
over its lifetime supply investments
again so for example if the given
machine is expected to yield receipts of
1200 and the running expenses will be
200 then the prospective yield will be
1200 minus 1200
divided by sorry
supply price multiplied by
100 a particular
equation m
e
marginal
rate
so it refers to the cost of borrowing
money
for financing the investment okay
there exists an inverse relationship
between roi
and the volume of investment casa
relationship and inverse relationship
just
spending
the profitability of an investment can
be worked out with the
worked out by comparing mei with roi if
mei is more than ry then investment is
profitable
mei that is marginal efficiency of
investment
expected
so
um
for instance if an entrepreneur has to
pay 12 percent rate of interest on a
loan
acquired by him and the expected rate of
rate of profit that is mei is 20
then he
foreign
[Applause]
marginal efficiency
thank you
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