Demand for Savings
The-demand for capital goods comes from firms which desire to invest, that is, to purchase or to make new capital goods. Capital goods arc demanded because they can he used to produce consumer goods – because they have a revenue productivity like all other factors. For any given type of capital asset. e.g a machine. it is possible to draw a marginal revenue productivity curve showing the addition made to the total revenue by an additional unit of a machine at various levels of the stock of that machine. We have said that capital, like other factors of production, has marginal revenue productivity. But The marginal revenue productivity of capital is a more complex concept than that of other factors. because capital has a life of many years. A capital asset continues to yield returns for many years. Therefore, the enter- Entrepreneurs have to take into consideration the uncertainties of the future and estimate the percentage Yield or returns from capital after making allowance for n maintenance and operating costs. In other words. they to find out the net expected return of a manna u it f capital expressed as percentage of the L of capital asst. The more capital assets of a gl an entrepreneur has. the less revenue or Louisville he will expect to earn by purchasing one more n chine of the same kind. Therefore, the marginal rcCllC productivity curve of capital slopes down.”, towards the right.
Now. under perfect competition. it profitable for a firm to purchase any factor up to the point at which the price of that factor equal its marginal revenue productivity. The price of the savings required to purchase the capital goods is obviously the rate of interest. Hence. the entrepreneur will demand capital goods or (which is the same thing) ‘will demand savings to purchase capital goods’ up to the point at which the expected net rate of return on the capital goods equals the rate of interest. Since the marginal revenue productivity curve of capital slopes downwards, it follows that, as the rate of interest falls, more capital goods will be demanded and also more money will be required to purchase these capital goods. The way in which the demand for capital goods rises as the rate of interest where MRP, is the marginal revenue productivity curve, On the Y-axis net rate of return on capital and the of interest are shown, while X-axis represents the bouillon capital. A,tor role of interest. OM amount of capital is delineated. This is so because only at OM amount of ital the falling net rate of return on capital becomes equal to the prevailing rate of interest Or. Now, if the rate of interest falls from Or.to Or’, the amount of capital demanded will increase from OM to OM’, since at OM’the falling net rate of return equals the new interest rate Or TITUS. it is clear that the marginal revenue productivity curve of capital shows the demand for capital and further that the demand curve for capital (or demand for .savings 10 buy the capital) slopes downwards towards the is true of individual firms, of individual industries and of the community as a whole. Thus. we conclude that demand for individual capital goods and for capital goods in general will increase as the rate of interest falls .