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Home » Economics Homework Help » Macroeconomics Help » Capital Accumulation
Capital Accumulation
In this section, we explain the process of capital accumulation to its desired level under two conditions:

(i) A decrease in the interest rate, given the MEC schedule, and

(ii) Increase in efficiency of capital causing an upward shift in the MEC schedule interest rate remaining constant.

Decrease in interest rate and capital accumulation

The process of capital accumulation by the firms in response to a fall in the market rate of interest is illustrated, suppose that the MEC schedule is given as shown in panel (a) that the rate of interest is given at 12 percent. At this interest rate, the actual and the desired stock of capital is worth $500 million. Here, all the firms have optimized their stock of capital their demand for capital is limited to the replacement demand and net investment is zero at the existing rate of interest, under these conditions, the production capacity fo the capital goods industry world be limited to the replacement demand plus their inventories.

The process of capital accumulation is explained below. Suppose that the initial MEL schedule is given b MEL in panel (b) two things are important to note here, one only one MEL schedule is associated with a given capital stock. Thus MEL is associated with the capital stock of $500 million in panel (a) two in difference with MEL schedule here is concave. The concavity of the MEL schedule implies the rising cost of capital supply. It is derived from the upward bending capital supply curve.

Upward shift in MEC schedule and capital accumulation

In this section, we explain ht effect of an upward shift in the MEC schedule on investment and the process of capital accumulation, with a given interest is the graphical analysis of the effect of an upward shift in the MEC schedule on investment demand and on the capital stock is presented that the initial MEC schedule is given as MEC, in panel (a) of the figure and the market rate of interest is given at 8 percent. Given the schedule MEC and 8 percent interest rate, the optimum stock of capital is determined at $500 million. The optimality of capital stock means that net investment is zero. Now let the MEC schedule shift upward from MEC to MEC.

The increase in the demand for additional capital warrants an increase in the production of additional capital goods. How the question arises: how much capital goods can be produced in the first period? As shown in panel (a) of the figure, given the interest rate at 8 percent and the stock of capital at $500 millions, the award shift in the MEC schedule increases MEC to 12 percent, 4 percent higher than the previous MEC. The MEL schedule associated with this stock of capital and MEC is shown by the schedule MEL in panel (b) of the figure. The schedule MEL intersects the 8 percent line at point N determining the additional capital production at $40 million; it means that the net investment in the first period will increase by $40 million. The increases the stock of capital to $540 million, as a result MEC falls to 10 percent. If capital stock were to be maintained at $540 million. As a result MEC falls to 10 percent. If capital stock were to be maintained at $540 million, net investment would be equal to zero.

At zero net investment there will be another MEL schedule that is schedule MEI. The MEC at 10 percent is still higher than the interest rate (8 percent). It can be seen in panel (b) that MEI intersects the 8 percent interest line at point M. this implies an additional net investment of $25 million in the second period increasing the stock of capital to $565 million, since MEC is still higher that the interest rate, further investment is still warranted, by the logic explained shove, the MEL schedule will shift downward increasing the net investment by $15 million. The net investment of $15 million in the third period relapses the stock of capital to tits desired level at $500 million. At this stock of capital MEC= I = MEL, therefore, the net investment falls once again to zero level.

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