ABSTRACT
Chapters 11 and 12 of KEYNES presents his analysis of the investment decision of the firm and the importance of expectations in this regard. Chapter 11 refers to the marginal efficiency of capital (MEC) concept – effectively the internal rate of return of a capital project. However he emphasizes that it is the project’s prospective MEC that is the important value with regard to the firm’s decision to invest. Thus it is necessary to consider expectations. Chapter 12 presents his theory of long-term expectations. He emphasized the “state of confidence” – the extent to which businessmen believe that their current expectations are correct – as being the most important determinant of investment decisions. His justification for this is the result, he argued, of the “extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made” (p.149). Thus, according to Keynes, we do not have the information that would allow for any sort of precise calculation – we exist in a world of uncertainty, in Knightian terms. This in turn leads him to identify the concept of “animal spirits” – an innate drive which, he argues, causes people to take action in spite of the lack any calculable benefits – as being an important component of human behaviour under uncertainty.
