Investment Demand Curves
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Investment Demand Curve
Having discussed the derivation of the MEC curve, we shall now proceed from the MEC curve to the investment demand curve.
We have seen earlier that investment will be pushed up to the point where the marginal efficiency of capital (MEC) will be equal to the rate of interest (r). It follows that given the MEC schedule, the level of investment demand is determined by the rate of interest. Thus, by substituting the marginal efficiency of capital by the rate of interest we get the investment demand schedule.
If at Rs. 20 crores investment, the marginal efficiency of capital 6%, it can be inferred that at an interest rate of 6%, Rs. 20 crores of investment will be forthcoming.
The investment demand curve relating investment to alternative levels of interest. In this, we measure I and r along the vertical axis and the investment demand must be equal to Rs. 20 crores (I1) because only this level of investment decreases to Rs. 15 crores (I1); since only at this level of investment the MEC = i. At 10% rate of interest (i2 = r2) investment decreases to Rs. 10 crores or so on. This means that the MEC curve itself is the investment demand curve. Since the MEC is downward sloping the investment demand curve will also be downward sloping. It shown that there is in inverse relationship between the rate of interest and investment.
8 per cent, which is equal to the rate of interest. Thus, and upward shift in the investment demand schedule, given the rate of interest, will increase level of investment downward shift will reduce the level of investment.
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We have seen earlier that investment will be pushed up to the point where the marginal efficiency of capital (MEC) will be equal to the rate of interest (r). It follows that given the MEC schedule, the level of investment demand is determined by the rate of interest. Thus, by substituting the marginal efficiency of capital by the rate of interest we get the investment demand schedule.
If at Rs. 20 crores investment, the marginal efficiency of capital 6%, it can be inferred that at an interest rate of 6%, Rs. 20 crores of investment will be forthcoming.
The investment demand curve relating investment to alternative levels of interest. In this, we measure I and r along the vertical axis and the investment demand must be equal to Rs. 20 crores (I1) because only this level of investment decreases to Rs. 15 crores (I1); since only at this level of investment the MEC = i. At 10% rate of interest (i2 = r2) investment decreases to Rs. 10 crores or so on. This means that the MEC curve itself is the investment demand curve. Since the MEC is downward sloping the investment demand curve will also be downward sloping. It shown that there is in inverse relationship between the rate of interest and investment.
Shift in the Investment Demand Curve
The investment demand schedule changes fo the same reasons which cause MEC to change. When MEC0curve shifts from MEC0 to MEC0 the investment demand curve also shifts from II to I1 I1. Before the shift in the MEC schedule, the level of investment corresponding to the rate of interest of say, i = 8%, is I1= Rs. 15 crores. But as the MEC schedule shifts upwards, the expected rate of return (r2 = 10%) is higher than the market rate of interest (i1 = 8%) at that level of investment. Consequently investment increases to Rs. 20 crores, causing the expected rate of return to discrete8 per cent, which is equal to the rate of interest. Thus, and upward shift in the investment demand schedule, given the rate of interest, will increase level of investment downward shift will reduce the level of investment.
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