Class 12 Macroeconomics Chapter 4 |Determinants of Investment 2022-23

Summary

The 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.