Marginal Efficiency of Capital

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Marginal Efficiency of Capital


in bourgeois political economy, a term signifying the expected rate of profit on an additional unit of capital. The concept, which was most clearly formulated by J. M. Keynes (Great Britain), was widely used by the Keynesian school.

According to Keynes, the marginal efficiency of capital is the prime determinant guiding the capitalist’s decisions on investments, the size of which depends on the expected rate of profit. The second determinant of the capitalist’s investment decisions is the rate of interest. The capitalist compares the marginal efficiency of capital and the rate of interest. Investments are made only when the rate of interest on capital is lower than the expected rate of profit from invested capital. As the gap between these two indicators increases, the capitalist’s incentive to invest becomes stronger. Thus, the volume of current investment depends on the relationship between the marginal efficiency of capital and the rate of interest. An increase in the rate of interest produces a decrease in the marginal efficiency of capital and a decline in investment. A decrease in the rate of interest, accompanied by increased availability of credit, produces an increase in investment.

Keynes assumed that the entrepreneur would expand his investments until the marginal efficiency of capital fell to the level of the rate of interest. This, however, is an untenable assumption. Keynes believed that the entrepreneur was using only borrowed capital. In reality, however, to have access to borrowed capital, the entrepreneur must have his own capital. Therefore, the question of the interest rate can only be of subordinate importance to him. Moreover, Keynes accepted the law of diminishing returns on capital, a principle that is widely held in bourgeois political economy. According to this law, as investment increases, each additional unit of capital brings a decline in the productivity, or efficiency, of capital. Keynes does not explain why the rate of profit should decline with an increase of capital applied to production or why, in the final analysis, it must decline to the level of the interest rate.

Keynes’ theory of the marginal efficiency of capital is a crude, oversimplified attempt to account for the tendency toward a falling rate of profit, part of the reality of capitalism discovered by K. Marx. Referring to this tendency as a reduction in the marginal efficiency of capital, Keynes associated it with surplus capital. In his opinion, an increase in investments results in the creation of new capital goods, which compete with the old ones. Keynes believed that the expansion of output would inevitably lead to lower prices, which would reduce the expected profit. This situation would continue until the interest rate was higher than the marginal efficiency of capital. If, however, the interest rate fell to zero, capital would be supplied continuously until the market was glutted. At this point, surplus capital (capital with no outlet for investment) would emerge, and the rate of profit would fall catastrophically.

Keynes offered a distorted analysis of the tendency toward a declining rate of profit—a tendency that operates even under monopoly capitalism. His interpretation fails to make a clear distinction between the rate and volume of profit, offers an incorrect explanation of the factors causing the rate of profit to fall, and misrepresents the effect of declining profitability on capitalist accumulation.


Keynes, J. M. Obshchaia teoriia zaniatosti, protsenta i deneg. Moscow, 1948. (Translated from English.)
Haberler, G. von. Protsvetanie i depressiia. Moscow, 1960. (Translated from English.)
Bliumin, I. G. Kritika burzhuaznoi politicheskoi ekonomii, vol. 2. Moscow, 1962.


References in periodicals archive ?
Keynes accuses Mises and Hayek of "confusing the marginal efficiency of capital with the rate of interest" (Keynes, 1936, p.
A collapse of the marginal efficiency of capital means autonomous investment collapses.
Keynes argued that the soundness of the usury proscription resided in the Scholastics' effort to reward investment by keeping the marginal efficiency of capital high and not to reward mere savings by keeping the rate of interest low.
To a Schoolman, the marginal efficiency of capital would be another name for the loss emergent or gain cessant upon the relinquishing of money, the true cost of the alternative opportunities.
If the interest rate is forced down to a sufficiently low point on the schedule of the marginal efficiency of capital, then the inducement to invest will be strengthened and the equilibrium level will be raised to full employment (Keynes, 1936, pp.
Moreover, if this expansive monetary policy were utilized to sustain full employment for an extremely long period of time, such an abundance of investment goods would be created that the marginal efficiency of capital would decline very drastically.
For Keynes, once the principle of effective demand determines equilibrium in a laissez-faire monetary economy, the trade cycle is driven by fluctuations in the marginal efficiency of capital.
Second, Keynes proposed a policy to increase the expected marginal efficiency of capital and reduce its variance in terms of what he called the 'socialization' of investment.
is] already larger" than justified by the volume of aggregate demand, the entrepreneurs' marginal efficiency of capital is approaching zero.
In particular, as interest rates rise, shorter projects will be preferred, while longer projects are preferred when interest rates are lower In the marginal efficiency of capital approach, there is no such switching.
Keynes also had a real capital rate of interest, while he called the marginal efficiency of capital as well as a monetary rate of interest.
In distinct contrast, the Keynesians adopt the rate of return approach to economic calculation in which the marginal efficiency of capital is used to rank investment projects.