CHAPTER II

THE MARGINAL EFFICIENCY OF CAPITAL

I

When a man buys an investment or capital- asset, hepurchases the right to the series of prospective returns,which he expects to obtain from selling its output, afterdeducting the running expenses of obtaining that out-put, during the life of the asset. This series of annui-ties Q1, Qa . . . Qn it is convenient to call the pro-spective yield of the investment.

Over against the prospective yield of the invest-ment we have the supply price of the capital- asset,meaning by this, not the market- price at which an assetof the type in question can actually be purchased in themarket, but the price which would just induce a manu-facturer newly to produce an additional unit of suchassets , i.e. what is sometimes called its replacement cost.The relation between the prospective yield of a capital-asset and its supply price or replacement cost, i.e. therelation between the prospective yield of one more unitof that type of capital and the cost of producing thatunit, furnishes us with the marginal efficiency of capitalof that type. More precisely, I define the marginalefficiency of capital as being equal to that rate of dis-count which would make the present value of the seriesof annuities given by the returns expected from thecapital- asset during its life just equal to its supplyprice. This gives us the marginal efficiencies ofparticular types of capital- assets. The greatest of

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