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Define the ‘Marginal Efficiency of Capital’ (MEC) - Leaving Cert Economics - Question 2 - 2013

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Define the ‘Marginal Efficiency of Capital’ (MEC). Outline two possible reasons for a fall in MEC. Definition: Reason 1: Reason 2:

Worked Solution & Example Answer:Define the ‘Marginal Efficiency of Capital’ (MEC) - Leaving Cert Economics - Question 2 - 2013

Step 1

Definition:

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Answer

Marginal Efficiency of Capital (MEC) is defined as the extra profit earned as a result of employing one additional unit of capital. This concept reflects the expected return on investment from the last unit of capital employed.

Step 2

Reason 1:

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Answer

An increase in interest rates can lead to a fall in MEC. Higher interest rates typically increase the cost of borrowing, which can reduce investment demand and thus lower the profitability of using additional capital.

Step 3

Reason 2:

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Answer

A decrease in the productivity of capital can also result in a fall in MEC. If the capital used becomes less effective or efficient, the extra profit generated from each additional unit of capital will diminish, impacting overall profitability.

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