marginal efficiency of capital

Dictionary of Business Terms for: marginal efficiency of capital
marginal efficiency of capital

annual percentage yield earned by the last additional unit of capital; also known as marginal productivity of capital, natural interest rate, net capital productivity, and rate of return over cost. The significance of the concept to a business firm is that projects whose marginal efficiency of capital exceeds the market rate of interest are profitable to undertake.

Dictionary of Finance and Investment Terms for: marginal efficiency of capital
marginal efficiency of capital

annual percentage yield earned by the last additional unit of capital. It is also known as marginal productivity of capital, natural interest rate, net capital productivity, and rate of return over cost. The significance of the concept to a business firm is that it represents the market rate of interest at which it begins to pay to undertake a capital investment. If the market rate is 10%, for example, it would not pay to undertake a project that has a return of 9½%, but any return over 10% would be acceptable. In a larger economic sense, marginal efficiency of capital influences longterm interest rates. This occurs because of the law of diminishing returns as it applies to the yield on capital. As the highest yielding projects are exhausted, available capital moves into lower yielding projects and interest rates decline. As market rates fall, investors are able to justify projects that were previously uneconomical. This process is called diminishing marginal productivity or declining marginal efficiency of capital.

Copyright (c) by Barron's Educational Series. Reprinted by arrangement with the publisher of this site.