MEC (Marginal Efficiency of Capital) depends on the businessmen’s expectations, which increases due to invention and goes down due to any threat to the returns on investment. It is also affected by the annual spirit of the entrepreneur. That is why investments are not always calculations but also irrational optimism. Business expectations are based on existing events and partly future facts. The investment decision is not done on actual investment but on the future yields.
Therefore, huge expenditure is required but actual returns start later. These two types of expectations – short term and long term are based on existing facts, whereas long term expectation is based on the future events.
Acceleration Principle:
The multiplier and Acceleration Principle are parallel concepts. This principle is also called Principle of Acceleration.
Multiplier shows the effect of consumption on investment.
Acceleration shows the effect of investment on consumption.
This is so because to produce the final goods, capital goods are also required. Therefore, if you want to increase the final product, the capital goods which are inputs for these final goods should also be increased. When consumption increases, the demand for factors of production will also increase.
There are certain practical limitations to this principle.
No excess capacity: If consumer goods sectors have excess capacity, induced investment will not increase. Only after the utilization of idle capacity, the principle will start operating.
Surplus capacity: Acceleration principle works on a very tough condition that there will be excess capacity in investment industry but not in the industry producing consumer goods. It is assumed that there is surplus capacity in investment goods industry, but if there is no excess capacity in machine making industries there will be postponed delivery and the acceleration will be low.
Availability of resources: When demand increase for capital goods that means increase in production, which again means more employment. So, there should be enough unemployed resources available. But only when the full employment level reached there is difficulty in expanding the production.
Nature of Demand: The demand for consumption goods should be more or less permanent for acceleration principle to work, because if the demand increase is temporary, then that will increase demand for capital goods as these goods are expensive.
The relationship between consumption, profit maximization and investment is shown by acceleration principle.
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