Q.(a) What are the differences between Marginal Efficiency of Capital (MEC) and Marginal Efficiency of Investment (MEI) ?

(a) MEC is the expected yield on an extra unit of capital (a stock concept), while MEI is the expected yield on extra investment allowing for the rising supply price of capital (a flow concept). (b) Fisher's quantity theory (MV = PT) holds that the price level is directly proportional to the quantity of money. (a) Differences between MEC and MEI | Basis | Marginal Efficiency of Capital (MEC) | Marginal Efficiency of Investment (MEI) | | --- | --- | --- | | Meaning | Expected rate of return over cost on an additional unit of capital asset | Expected rate of return on an additional unit of investment | | Concept | Relates to the stock of capital | Relates to the flow of investment | | Supply price of capital | Assumes the supply price of capital is given/constant | Takes into account the rise in the supply price of capital as investment rises | | Basis of determination | Determines the desired/optimum stock of capital | Determines the actual rate of investment in a period | | Slope/steepness | MEC curve is flatter | MEI curve is steeper (falls faster) because rising supply price lowers returns | - Both fall as capital/investment increases, but MEI is more relevant for deciding the actual amount of investment because it recognises that producing more capital goods raises their cost. (b) Irving Fisher's Quantity Theory of Money (described in words) - Fisher's theory (the cash-transactions approach) states that the general price level (P) is determined by the quantity of money (M) and varies directly and proportionately with it. - The equation of exchange is: MV + M'V' = PT, where - M = quantity of money in circulation, V = its velocity of circulation, - M' = credit/bank money, V' = its velocity, - P = general price level, T = total volume of transactions (goods and services). - In the simple form (ignoring credit money) it becomes MV = PT, so P = MV / T. - Assumptions: V, V' and T are constant in the short run and are independent of the money supply. - Conclusion: si …