INVESTMENT DEMAND CURVE

It has explained earlier that a firm continues to invest so long as the marginal efficiency of capital (MEC) becomes equal to the market rate of interest (r). Therefore, given the MEC schedule, the level of investment demand is determined by rate of interest. By substituting the market rate of interest for the values of MEC, we get the investment demand schedule and the investment demand curve likewise. Figure 4.6 shows the investment demand curve relating the investment (on X-axis) with the different levels of interest (in Y-axis). Following the hypothetical MEC schedule shown in this chapter, at Rs 25 crores of investment will be forthcoming. Thus, investment demand corresponding to the interest rate of 15% is Rs 25 crores, because the MEC will be equal to the rate of interest (r1) only at this investment level. Similarly, when the rate of interest decreases to 12%, the investment increases to Rs 27 crores. At 12% rate of interest i2 = r2 . Further, at 10% market, rate of interest i3 = r3 . The investment increases to Rs.31 crores and so on. It can, thus, be inferred that the MEC curve is also downward slopping.


The investment demand curve expresses an inverse relationship between the rate of interest and the investment. It can also shift for the same reasons which cause the MEC to change. Given the rate of interest, an upward shift in the investment demand curve will increase the level of investment, while a downward shift will reduce the investment level. In figure 4.6, the level of investment corresponding to the interest rate of say, r = 12% is Rs 27 crores. When the investment demand curve shifts upwards the MEC at 12% is higher than the rate of interest 10% at that level of investment. As a result, the investment rises to Rs.31 crores, causing the MEC to decline to 10%, which is equal to the rate of interest.


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