Background
Marginal efficiency of investment (MEI) refers to the highest interest rate at which an investment project is expected to break even. This concept is central to understanding investment decision-making processes in economics, specifically in determining why certain projects proceed while others do not.
Historical Context
The concept of MEI was popularized by economist John Maynard Keynes during the early 20th century. Keynes introduced this idea as part of his broader framework for understanding macroeconomic fluctuations and investment behavior.
Definitions and Concepts
MEI combines two critical aspects:
- Immediate Profitability: The immediate gains expected from an investment.
- Rate of Decline: Possible reductions in profits due to decreasing real prices of output, or increasing real costs like wages and fuel.
Major Analytical Frameworks
Classical Economics
For classical economists, investment decisions were seen primarily through the lens of supply and demand for capital, with less emphasis on expectations and future profitability.
Neoclassical Economics
Neoclassical economics aligns MEI with the marginal product of capital, stressing that investments continue until the marginal product equals the cost of capital.
Keynesian Economics
Keynesian perspectives highlight MEI in relation to investor expectations and the role of uncertainty. They argue that investors will proceed with projects if the MEI is higher than the interest rate plus a requisite risk premium.
Marxian Economics
Marxian economists view MEI through the dynamics of capitalist production and profitability crises, focusing on how profit rates influence investment cycles.
Institutional Economics
Institutional economists consider how habits, norms, and regulations impact investor expectations and thus MEI, broadening analysis beyond pure profit considerations.
Behavioral Economics
Behavioral economists investigate how psychological factors and cognitive biases influence investor decisions on projects with varying MEI.
Post-Keynesian Economics
Post-Keynesian frameworks build upon Keynes, emphasizing uncertainties and the subjectivity inherent in calculating MEI, often critical of the oversimplification of purely quantitative approaches.
Austrian Economics
Austrian economists critique aggregated measures like MEI, advocating instead individual assessments of project profitability, taking time preferences deeply into account.
Development Economics
From the development economics perspective, MEI can play a role in understanding the allocation of investment in emerging markets, where risks and returns can be distinctly different.
Monetarism
Monetarist views may focus less on MEI directly, viewing interest rates as instruments for influencing broader monetary conditions which indirectly impact MEI.
Comparative Analysis
MEI as a concept bridges various economic schools of thought by offering a mechanism to decide the feasibility of investments. Classical and neoclassical schools emphasize cost and return dynamics, while Keynesian and institutional approaches pivot around expectations and market imperfections.
Case Studies
A study of MEI might involve analyzing investment patterns across different economic climates, examining how changes in interest rates and risk premiums influence the decision to proceed with a project.
Suggested Books for Further Studies
- “The General Theory of Employment, Interest, and Money” by John Maynard Keynes
- “Investment Under Uncertainty” by Avinash Dixit and Robert Pindyck
- “Behavioral Finance: Psychology, Decision-Making, and Markets” by Noam Nisan et al.
Related Terms with Definitions
- Interest Rate: The cost of borrowing money, often expressed as a percentage.
- Risk Premium: The extra return demanded by investors to compensate for the increased risk of an investment.
- Expected Profitability: The anticipated financial return from an investment project.
