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(G) MEC and speculative motive:
i) MEC: Level of employment is governed by the size of the effective demand. There are two components of effective demand :
C, the consumption expenditure and
I, the private or induced investment expenditure
Keynes has defined such investment activity in the form of any expenditure which has the capacity to promote employment opportunities. Therefore mere paper investment in the form of purchase of shares, bonds, securities etc. cannot qualify Keynes’ concept of investment. We have seen that the problem of unemployment arises because of frequent deficiencies in the consumption expenditure. Under the classical system such deficiency is taken care of by automatic and equivalent increases in the induced investment expenditure via appropriate adjustments in the rate of interest. But Keynes does not agree with this argument. He argues that the private investment decisions are not governed by deficiency in the consumption expenditure nor by rate of interest in isolation. It is dependent on the profit expectations of the producers which he calls as Marginal Efficiency of Capital (MEC). He proceeds to analyze and show that the behavior of the MEC is a highly complicated phenomenon. Its value depends on the general state of the economy rather than rate of interest, though the lower rate of interest is favorable to a reasonably high value of the MEC. He has defined the concept of MEC as follows:
Keynes says, "I define the Marginal Efficiency of Capital as being equal to the rate of discount which would make the present value of the series of annuities given by returns expected from the capital asset during it’s life just equal to its supply price."
MEC therefore depends upon two things. On the one hand there is value (V) of the capital assets and on the other is the cost of replacement cost or supply price (Cr) of these capital assets. But both these quantities cannot be measured and compared in a simple way. This is because capital assets that are durable and they keep on yielding returns over their life span. Again the replacement cost is not based on the present market conditions but it is future expected cost to be incurred after end of the life of present asset. Since both these sums refer to future course of time they have to be discounted at some rate since future and present values cannot be ordinarily equated. We have then two series of annual installments of yields and of costs of the capital assets and two rates of discount for the two series. If rate of discount on returns is symbolically stated as 'r' and that of replacement cost as 'c' and the market rate of interest as 'I' then we have:
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