Marginal Efficiency of Capital and Business Expectation

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.

An Evaluation of Loss and Benefit Due to Tax in Property Market

We can evaluate loss and benefit from the economic policies by the government. Now we will discuss the gain and loss in consumer surplus due to tax and subsidies. We can understand the loss in consumer surplus by imposing the indirect tax with an example. Indirect tax is the tax that we pay when we are paying the price for a commodity. Suppose the supply is perfectly elastic for scooters, the demand curve for scooter is downward sloping.

Evaluating the loss and benefit due to tax

In the above figure, the number of scooters sold shown on X-axis and the price of scooters is shown on Y-axis. OP is the price and OQ is the number of scooters sold. The consumer surplus price OP is DCP. Now, if indirect tax is imposed on scooter, the price will increase to OP1 and the number of scooter sold decreases to OQ1. Thus the consumer surplus will decrease to DP1A. There is a decrease in consumer surplus by P1ACP. There are two parts in this is a decrease in Consumer Surplus P1ACP.

P1ABP – This decrease in consumer surplus is because of increase in price.

ABC – This decrease in consumer surplus is because of decrease in the number of scooters sold.

ABC is the extra burden due to the sales tax. P1ABP is the loss in consumer surplus which goes to the government as revenue. But ABC is excess burden or net loss in welfare, which is called Dead weight loss. This part of loss in welfare goes nowhere. Indirect tax distorts the price of scooter and decrease the demand for scooter. So the burden of indirect tax is more than direct tax.

Direct tax is superior to indirect tax because if the government takes away P1ACP by direct tax then the loss equal to ABC would not be born by the public. This evolution is followed in property market also.