Marginal efficiency of investment, in economics, expected rates of return on investment as additional units of investment are made under specified conditions and over a stated period of time. A comparison of these rates with the going rate of interest may be used to indicate the profitability of investment. The rate of return is computed as the rate at which the expected stream of future earnings from an investment project must be discounted to make their present value equal to the cost of the project.

As the quantity of investment increases, the rates of return from it may be expected to decrease because the most profitable projects are undertaken first. Additions to investment will consist of projects with progressively lower rates of return. Logically, investment would be undertaken as long as the marginal efficiency of each additional investment exceeded the interest rate. If the interest rate were higher, investment would be unprofitable because the cost of borrowing the necessary funds would exceed the returns on the investment. Even if it were unnecessary to borrow funds for the investment, more profit could be made by lending out the available funds at the going rate of interest.

The MEI curve represents the interest elasticity of demand for investment (or capital goods), or in other words, how responsive investment is to a change in interest rates. Interest rates represent the cost of borrowing. Theoretically, the lower the rate of interest, the cheaper it is for firms to finance investment, and the more profitable the investment will be. Hence, the level of investment will rise.


Keynes, however, suggested that investment is in fact relatively unresponsive to changes in interest rates, particularly at the extreme ends of the Trade Cycle. During a recession, businessmen are generally pessimistic about the future outlook and there is also likely to be excessive unused productive capacity, which prevents a fall in interest rates from stimulating I. On the other hand, during a boom, their optimism may cause them to disregard high interest rates. Hence, MEI is more likely to look like the relatively inelastic MEI1 than the relatively elastic MEI2.