T h e Production Function a nd th e T h e ory

of C a p ita l
INT RODUC T ION
T h e domina nce in ne o-cl a ssica l e conomic te a ch ing of th e conce p t of a p roduction
f unction, in wh ich th e re l a tive p rice s of th e f a ctors of p roduction a re e xh ibite d a s a
f unction of th e ra tio in wh ich th e y a re e mp l oy e d in a give n sta te of te ch nica l know-
l e dge , h a s h a d a n e ne rva ting e f f e ct up on th e de ve l op me nt of th e subje ct, f or by con-
ce ntra ting up on th e que stion of th e p rop ortions of f a ctors it h a s distra cte d a tte ntion
f rom th e more dif f icul t but more re wa rding que stions of th e inf l ue nce s gove rning th e
sup p l ie s of th e f a ctors a nd of th e ca use s a nd conse que nce s of ch a nge s in te ch nica l
knowl e dge .
More ove r, th e p roduction f unction h a s be e n a p owe rf ul instrume nt of mis-
e duca tion. T h e stude nt of e conomic th e ory is ta ugh t to write 0 f
f
(L, C ) wh e re L is
a qua ntity of l a bour, C a qua ntity of ca p ita l a nd 0 a ra te of outp ut of commoditie s.'
He is instructe d to a ssume a l l worke rs a l ike , a nd to me a sure L in ma n-h ours of
l a bour;
h e is tol d some th ing a bout th e inde x-numbe r p robl e m invol ve d in ch oosing a unit of
outp ut ; a nd th e n h e is h urrie d on to th e ne xt que stion, in th e h op e th a t h e wil l f orge t
to a sk in wh a t units C is me a sure d. Be f ore e ve r h e doe s a sk, h e h a s be come a p rof e ssor,
a nd so sl op p y h a bits of th ough t a re h a nde d on f rom one ge ne ra tion to th e ne xt.
T h e que stion is ce rta inl y not a n e a sy one to a nswe r. T h e ca p ita l in e xiste nce a t
a ny mome nt ma y be tre a te d simp l y a s " p a rt of th e e nvironme nt in wh ich l a bour
works."2 We th e n h a ve a p roduction f unction in te rms of l a bour a l one . T h is is th e
righ t p roce dure f or th e sh ort p e riod with in wh ich th e sup p l y of concre te ca p ita l goods
doe s not a l te r, but outside th e sh ort p e riod it is a ve ry we a k l ine to ta ke , f or it me a ns
th a t we ca nnot distinguish a ch a nge in th e stock of ca p ita l (wh ich ca n be ma de ove r
th e l ong run by a ccumul a tion) f rom a ch a nge in th e we a th e r (a n a ct of God).
We ma y l ook up on a stock of ca p ita l a s th e sp e cif ic l ist of a l l th e goods in e xiste nce
a t a ny mome nt (incl uding work-in-p rogre ss in th e p ip e l ine s of p roduction). But
th is a ga in is of no use outside th e strict bounds of th e sh ort p e riod, f or a ny ch a nge in
th e ra tio of ca p ita l to l a bour invol ve s a re -orga nisa tion of me th ods of p roduction a nd
re quire s a ch a nge in th e sh a p e s, size s a nd sp e cif ica tions of ma ny or a l l th e goods
a p p e a ring in th e origina l l ist. 3
As soon a s we l e a ve th e sh ort p e riod, h owe ve r, a h ost of dif f icul tie s a p p e a r. Sh oul d
ca p ita l be va l ue d a ccording to its f uture e a rning p owe r or its p a st costs ?
Wh e n we know th e f uture e xp e cte d ra te of outp ut a ssocia te d with a ce rta in
ca p ita l good, a nd e xp e cte d f uture p rice s a nd costs, th e n, if we a re give n a ra te of inte re st,
we ca n va l ue th e ca p ita l good a s a discounte d stre a m of f uture p rof it wh ich it wil l
e a rn. But to do so, we h a ve to be gin by ta king th e ra te of inte re st a s give n, wh e re a s
th e ma in p urp ose of th e p roduction f unction is to sh ow h ow wa ge s a nd th e ra te of
inte re st (re ga rde d a s th e wa ge s of ca p ita l ) a re de te rmine d by te ch nica l conditions a nd
th e f a ctor ra tio.
i
T h rough out th is e ssa y we sh a l l be a bstra cting f rom l a nd a s a f a ctor of p roduction, so we wil l not
both e r th e stude nt with it.
2
Ke y ne s, Ge ne ra l T h e ory , p . 2 I 4
.
8 In Prof e ssor Robe rtson's e xa mp l e , wh e n a te nth ma n joins nine wh o a re digging
a
h ol e , nine more
e xp e nsive sp a de s a re turne d into nine ch e a p e r sp a de s a nd a bucke t to f e tch be e r. (Economic Fra gme nts,
P. 47-)
8I
Joan Robinson,
Review of Economic Studies, 21(2), 1953-1954, pp. 81-106
82 T HE REVIEW OF EC ONOMIC ST UDIES
Are we th e n to va l ue ca p ita l goods by th e ir cost of p roduction ? C l e a rl y mone y
cost of p roduction is ne ith e r h e re nor th e re unl e ss we ca n sp e cif y th e p urch a sing p owe r
of mone y , but we ma y cost th e ca p ita l goods in te rms of wa ge units, th a t is, in e f f e ct, to
me a sure th e ir cost in te rms of a unit of sta nda rd l a bour.
T o tre a t ca p ita l a s a qua ntity of l a bour time e xp e nde d in th e p a st is conge nia l to
th e p roduction-f unction p oint of vie w,
f or it corre sp onds to th e e sse ntia l na ture of
ca p ita l re ga rde d a s a f a ctor of p roduction. Inve stme nt consists, in e sse nce , in e mp l oy -
ing l a bour now in a wa y wh ich wil l y ie l d its f ruits in th e f uture wh il e sa ving is ma king
curre nt p roducts a va il a bl e f or th e worke rs to consume in th e me a ntime ; a nd th e
p roductive ne ss of ca p ita l consists in th e f a ct th a t a unit of l a bour th a t wa s e xp e nde d
a t a ce rta in time in th e p a st is more va l ua bl e to-da y th a n a unit e xp e nde d to-da y ,
be ca use its f ruits a re a l re a dy rip e .
But h e re we e ncounte r a f unda me nta l dif f icul ty wh ich l ie s a t th e root of th e wh ol e
p robl e m of ca p ita l . A unit of l a bour is ne ve r e xp e nde d in a p ure f orm. Al l work is
done with th e a ssista nce of goods of some kind or a noth e r. Wh e n Ada m de l ve d a nd
Eve sp a n th e re we re e vide ntl y a sp a de a nd a sp indl e a l re a dy in e xiste nce . T h e cost
of ca p ita l incl ude s th e cost of ca p ita l goods, a nd since th e y must be constructe d be f ore
th e y ca n be use d, p a rt of th e cost of ca p ita l is inte re st ove r th e p e riod of time be twe e n
th e mome nt wh e n work wa s done in constructing ca p ita l goods a nd th e time wh e n
th e y a re p roducing a stre a m of outp ut. T h is is not just a conse que nce of ca p ita l ism,
f or e qua l l y in a socia l ist socie ty a unit of l a bour, e xp e nde d to-da y , wh ich wil l y ie l d a
p roduct in f ive y e a rs' time , is not th e sa me th ing a s a unit wh ich wil l y ie l d a p roduct
to-morrow.
Fina l l y , e ve n if it we re p ossibl e to me a sure ca p ita l simp l y in te rms of l a bour
time , we stil l sh oul d not h a ve a nswe re d th e que stion: of wh a t units is C comp ose d ?
Wh e n we a re discussing a ccumul a tion, it is na tura l to th ink of ca p ita l a s me a sure d in
te rms of p roduct. T h e p roce ss of a ccumul a tion consists in re f ra ining f rom consuming
curre nt outp ut in orde r to a dd to th e stock of we a l th . But wh e n we conside r wh a t a ddi-
tion to p roductive re source s a give n a mount of a ccumul a tion ma ke s, we must me a sure
ca p ita l in l a bour units, f or th e a ddition to th e stock of p roductive e quip me nt ma de by
a dding a n incre me nt of ca p ita l de p e nds up on h ow much work is done in constructing
it, not up on th e cost, in te rms of f ina l p roduct, of a n h our's l a bour. T h us, a s we move
f rom one p oint on a p roduction f unction to a noth e r, me a suring ca p ita l in te rms of
p roduct, we h a ve to know th e p roduct-wa ge ra te in orde r to se e th e e f f e ct up on p ro-
duction of ch a nging th e ra tio of ca p ita l to l a bour. Or if we me a sure in l a bour units,
we h a ve to know th e p roduct-wa ge in orde r to se e h ow much a ccumul a tion woul d be
re quire d to p roduce a give n incre me nt of ca p ita l . But th e wa ge ra te a l te rs with th e
ra tio of th e f a ctors : one sy mbol , C , ca nnot sta nd both f or a qua ntity of p roduct a nd
a qua ntity of l a bour time .
Al l th e sa me , th e p robl e m wh ich th e p roduction f unction p rof e sse s to a na l y se ,
a l th ough it h a s be e n too much p uf f e d up by th e a tte ntion p a id to it, is a ge nuine
p robl e m. T o-da y , in country Al p h a , a l e ngth of roa dwa y is be ing cl e a re d by a f e w
me n with bul l doze rs ; in Be ta a roa d (of ne a r-e nough th e sa me qua l ity ) is be ing ma de
by some h undre ds of me n with p icks a nd ox-ca rts. In Ga mma th ousa nds of me n a re
working with woode n sh ove l s a nd l ittl e ba ske ts to re move th e soil . Wh e n a l l p ossibl e
a l l owa nce s h a ve be e n ma de f or dif f e re nce s in na tiona l ch a ra cte r a nd cl ima te , a nd f or
dif f e re nce s in th e sta te of knowl e dge , it se e ms p re tty cl e a r th a t th e ma in re a son f or
th is sta te of a f f a irs is th a t ca p ita l in some se nse is more p l e ntif ul in Al p h a th a n in
Ga mma . Looke d a t f rom th e p oint
of vie w of a n individua l ca p ita l ist, it woul d not
p a y to use Al p h a me th ods in Ga mma (e ve n if unl imite d f ina nce we re a va il a bl e ) a t th e
ra te of inte re st wh ich is rul ing, a nd l ooke d a t f rom th e p oint of vie w of socie ty , it
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 83
woul d ne e d a p rodigious e f f ort of a ccumul a tion to ra ise a l l th e l a bour a va il a bl e in
Ga mma e ve n to th e Be ta l e ve l of te ch nique . T h e p robl e m is a re a l one . We ca nnot
a ba ndon th e p roduction f unction with out a n e f f ort to re scue th e e l e me nt of common-
se nse th a t h a s be e n e nta ngl e d in it.
T HE QUANT IT Y OF C APIT AL
"C a p ita l " is not wh a t ca p ita l is ca l l e d, it is wh a t its na me is ca l l e d. T h e ca p ita l
goods in e xiste nce a t a mome nt of time a re a l l th e goods in e xiste nce a t th a t mome nt.
It is not a l l th e th ings in e xiste nce . It incl ude s ne ith e r a rubbish h e a p nor Mont Bl a nc.
T h e ch a ra cte ristic by wh ich " goods " a re sp e cif ie d is th a t th e y h a ve va l ue , th a t is
p urch a sing p owe r ove r e a ch oth e r. T h us, in country Al p h a a n e mp ty p e trol tin is not a
"
good," wh e re a s in Ga mma wh e re ol d tins a re a source of va l ua bl e industria l ra w
ma te ria l , it is.
T h e l ist of goods is quite sp e cif ic. It is so ma ny a ctua l p a rticul a r obje cts, ca l l e d
bl a st f urna ce s, ove rcoa ts,
e tc., e tc. Goods group e d unde r th e sa me na me dif f e r f rom
e a ch oth e r in th e de ta il s of th e ir p h y sica l sp e cif ica tions a nd th e se must not be ove r-
l ooke d. Dif f e re nce s in th e ir a ge s a re a l so imp orta nt. A bl a st f urna ce twe nty y e a rs
ol d is not e quiva l e nt to a bra nd ne w one of th e sa me sp e cif ica tion in oth e r re sp e cts,
nor is a n e gg twe nty da y s ol d e quiva l e nt to a bra nd ne w one . T h e re is a noth e r re l e va nt
ch a ra cte ristic of th e goods. An ove rcoa t re quire s one body to we a r it, a nd a n e gg one
mouth to e a t it. With out one body , or one mouth , th e y a re use l e ss, a nd two bodie s or
mouth s (a t a give n mome nt of time ) ca nnot sh a re in using th e m. But a bl a st f urna ce
ca n be use d by a ce rta in ra nge of numbe rs of bodie s to turn iron ore into iron. T h e re f ore
th e de scrip tion of a bl a st f urna ce incl ude s a n a ccount of its ra te of outp ut a s a f unction
of th e numbe r of bodie s op e ra ting it. (Since we sh a l l not discuss sh ort-p e riod p robl e ms,
th e numbe r of bodie s a ctua l l y working e a ch p ie ce of e quip me nt, in th e situa tions with
wh ich we sh a l l be conce rne d, is th e numbe r wh ich is te ch nica l l y most a p p rop ria te to it.)
T h e re is a noth e r a sp e ct of th e goods wh ich is quite dif f e re nt. Of two ove rcoa ts,
comp l e te l y simil a r in a l l th e a bove re sp e cts, one is on th e body of Mrs. Jone s, wh o is
p urring with inwa rd de l igh t a t h e r f ine a p p e a ra nce . Anoth e r is on th e body of Mrs.
Snooks, wh o is grizzl ing be ca use , h e r h usba nd's income be ing wh a t it is, sh e is obl ige d
to buy ma ss-p roduce d cl oth e s. In wh a t f ol l ows we sh a l l not discuss th is a sp e ct of
goods a t a l l . We ta ke it th a t a n ove rcoa t (Ma rk IV) is a n ove rcoa t (Ma rk IV), a nd
no nonse nse .
Now, th is e normous wh o's wh o of individua l goods is not a th ing wh a t we ca n
h a ndl e a t a l l e a sil y . T o e xp re ss it a s a qua a ntity of goods we h a ve to e va l ua te th e ite ms
of wh ich it is comp ose d. We ca n e va l ua te th e goods in te rms of th e re a l cost of p ro-
ducing th e m-th a t is, th e work a nd th e f orme rl y e xisting goods re quire d to ma ke
th e m, or in te rms of th e ir va l ue e xp re sse d in some unit of p urch a sing p owe r, or we ca n
e va l ua te th e m a ccording to th e ir p roductivity -th a t is, wh a t th e stock of goods wil l
be come in th e f uture if work is done in conjunction with it.
In a p osition of e quil ibrium a l l th re e e va l ua tions y ie l d e quiva l e nt re sul ts ; th e re
is a qua ntity wh ich ca n be tra nsl a te d f rom one numbe r to a noth e r by ch a nging th e
unit. T h is is th e de f inition of e quil ibrium. It e nta il s th a t th e re h a ve be e n no e ve nts
ove r th e re l e va nt p e riod of p a st time wh ich h a ve disturbe d th e re l a tion be twe e n th e
va rious va l ua tions of a give n stock of goods, a nd th a t th e h uma n be ings in th e situa tion
a re e xp e cting th e f uture to be just l ike th e p a st-e ntire l y de void of such disturbing
e ve nts. T h e n th e ra te of p rof it rul ing to-da y is th e ra te wh ich wa s e xp e cte d to rul e
to-da y wh e n th e de cision to inve st in a ny ca p ita l good now e xta nt wa s ma de , a nd th e
e xp e cte d f uture re ce ip ts, ca p ita l ise d a t th e curre nt ra te of p rof it, a re e qua l to th e
cost of th e ca p ita l goods wh ich a re e xp e cte d to p roduce th e m.
84 T HE REVIEW OF EC ONOMIC ST UDIES
Wh e n a n une xp e cte d e ve nt occurs, th e th re e wa y s of e va l ua ting th e stock of goods
p a rt comp a ny a nd no a mount of juggl ing with units wil l bring th e m toge th e r a ga in.
We a re a ccustome d to ta l k of th e ra te of p rof it on ca p ita l e a rne d by a busine ss a s
th ough p rof its a nd ca p ita l we re both sums of mone y . C a p ita l wh e n it consists of a s
y e t uninve ste d f ina nce is a sum of mone y , a nd th e ne t re ce ip ts of a busine ss a re sums
of mone y . But th e two ne ve r co-e xist in time . Wh il e th e ca p ita l is a sum of mone y ,
th e p rof its a re not y e t be ing e a rne d. Wh e n th e p rof its (qua si-re nts) a re be ing e a rne d,
th e ca p ita l h a s ce a se d to be mone y a nd be come a p l a nt. Al l sorts of th ings ma y h a p p e n
wh ich ca use th e va l ue of th e p l a nt to dive rge f rom its origina l cost. Wh e n a n e ve nt
h a s occurre d, sa y , a f a l l in p rice s, wh ich wa s not f ore se e n wh e n inve stme nt in th e p l a nt
wa s ma de , h ow do we re ga rd th e ca p ita l re p re se nte d by th e p l a nt ?
T h e ma n of de e ds, wh o h a s de cisions to ma ke , is conside ring h ow f uture p rosp e cts
h a ve a l te re d. He is conce rne d with ne w f ina nce or a ccrue d a mortisa tion f unds, wh ich
h e must de cide h ow to use . He ca nnot do a ny th ing a bout th e p l a nt (unl e ss th e
situa tion is so de sp e ra te th a t h e de cide s to scra p it). He is not p a rticul a rl y inte re ste d
(e xce p t wh e n h e h a s to ma ke out a ca se be f ore a Roy a l C ommission) in h ow th e ma n
of words, wh o is me a suring ca p ita l , ch oose s to va l ue th e p l a nt.'
T h e ma n of words h a s a wide ch oice of p ossibl e me th ods of e va l ua tion but none
of th e m is ve ry sa tisf a ctory . First, ca p ita l ma y be conce ive d of a s consisting e ith e r in
th e cost or in th e va l ue of th e p l a nt. If cost is th e me a sure , sh oul d mone y cost a ctua l l y
incurre d be re ckone d ? It is onl y of h istorica l inte re st, f or th e p urch a sing p owe r of
mone y h a s since ch a nge d. Is th e mone y cost to be de f l a te d ? T h e n by wh a t inde x ?
Or is ca p ita l to be me a sure d a t curre nt re p l a ce me nt cost ? T h e situa tion ma y be such
th a t no one in h is se nse s woul d buil d a p l a nt l ike th is one if h e we re to buil d now.
Re p l a ce me nt cost ma y be p ure l y a ca de mic. But e ve n if th e p l a nt is, in f a ct, due to be
re p l a ce d by a re p l ica of itse l f a t some f uture da te , we stil l h a ve to a sk wh a t p rop ort-ion
of th e va l ue of a bra nd ne w p l a nt is re p re se nte d by th is e l de rl y p l a nt? And th e
a nswe r to th a t que stion invol ve s f uture e a rnings, not cost a l one .
If th e ca p ita l is to be me a sure d by va l ue , h ow de cide wh a t th e p re se nt va l ue of
th e p l a nt is ? T h e p rice a t wh ich it coul d be sol d a s a n inte gra l wh ol e h a s not much
signif ica nce , a s th e ma rke t f or such tra nsa ctions is na rrow. T o ta ke its p rice on th e
Stock Exch a nge (if it is quote d) is to go be f ore a tribuna l wh ose cre de ntia l s a re dubious.
If th e ca p ita l -me a sure r ma ke s h is own judgme nt, h e ta ke s wh a t h e re ga rds a s l ike l y
to be th e f uture e a rnings of th e p l a nt a nd discounts th e m a t wh a t h e re ga rds a s th e
righ t ra te of inte re st f or th e p urp ose , th us triump h a ntl y sh owing th a t th e most
p roba bl e ra te of p rof it on th e ca p ita l inve ste d in th e p l a nt is e qua l to th e most a p p ro-
p ria te ra te of inte re st.
Al l th e se p uzzl e s a rise be ca use th e re is a ga p in time be twe e n inve sting mone y
ca p ita l a nd re ce iving mone y p rof its, a nd in th a t ga p e ve nts ma y occur wh ich a l te r
th e va l ue of mone y .
T o a bstra ct f rom unce rta inty me a ns to p ostul a te th a t no such e ve nts occur, so
th a t th e e x a nte e xp e cta tions wh ich gove rn th e a ctions of th e ma n of de e ds a re ne ve r
out of ge a r with th e e x p ost e xp e rie nce wh ich gove rns th e p ronounce me nts of th e ma n
of words, a nd to sa y th a t e quil ibrium obta ins is to sa y th a t no such e ve nts h a ve
occurre d f or some time , or a re th ough t l ia bl e to occur in th e f uture .
T h e a mbiguity of th e conce p tion of a qua ntity of ca p ita l is conne cte d with a
p rof ound me th odol ogica l e rror, wh ich ma ke s th e ma jor p a rt of ne o-cl a ssica l doctrine
sp urious.
I
A ma n of words but not of de e ds
Is l ike a ga rde nf ul l of we e ds."
T h is is sa dl y true of th e th e ory of ca p ita l .
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 85
T h e ne o-cl a ssica l e conomist th inks of a p osition of e quil ibrium a s a p osition
towa rds wh ich a n e conomy is te nding to move a s time goe s -by . But it is imp ossibl e f or
a sy ste m to ge t into a p osition of e quil ibrium, f or th e ve ry na ture of e quil ibrium is
th a t th e sy ste m is a l re a dy in it, a nd h a s be e n in it f or a ce rta in l e ngth of p a st time .
T ime is unl ike sp a ce in two ve ry striking re sp e cts. In sp a ce , bodie s moving f rom
A to B ma y p a ss bodie s moving f rom B to A, but in time th e stricte st p ossibl e rul e of
one -wa y tra f f ic is a l wa y s in f orce . And in sp a ce th e dista nce f rom A to B is of th e
sa me orde r of ma gnitude (wh a te ve r a l l owa nce y ou l ike to ma ke f or th e T ra de Winds)
a s th e dista nce f rom B to A ; but in time th e dista nce f rom to-da y to to-morrow is
twe nty -f our h ours, wh il e th e dista nce f rom to-da y to y e ste rda y is inf inite , a s th e
p oe ts h a ve of te n re ma rke d. T h e re f ore a sp a ce me ta p h or a p p l ie d to time is a ve ry
tricky knif e to h a ndl e , a nd th e conce p t of e quil ibrium of te n cuts th e a rm th a t wie l ds it.
Wh e n a n e ve nt h a s occurre d we a re th rown ba ck up on th e wh o's wh o of goods in
e xiste nce , -a nd th e " qua ntity of ca p ita l " ce a se s to h a ve a ny oth e r me a ning. T h e n
onl y th a t p a rt of th e th e ory of va l ue wh ich tre a ts of th e sh ort p e riod, in wh ich th e
p h y sica l stock of ca p ita l e quip me nt is give n, h a s a ny a p p l ica tion.
Ne ve rth e l e ss, some of th e inte rna l re l a tions be twe e n th e p a rts of a sy ste m ca n
be most e a sil y th ough t a bout by ima gining it to be in e quil ibrium, a nd a n e xa mina tion
of th e se re l a tions is use f ul , p rovide d th a t it is conducte d with due re ga rd to its l imita -
tions.
In wh a t f ol l ows we a re conce rne d with such inte rna l re l a tions, sh own by th e
p rop e rtie s of a n e quil ibrium situa tion-in p a rticul a r with th e inte rre l a tions be twe e n
th re e of its p rop e rtie s-th e qua ntity of ca p ita l , th e l a bour f orce , a nd th e sta te of
te ch nica l knowl e dge .
ASSUMPT IONS AND DEFINIT IONS
We must ma ke ce rta in dra stic a ssump tions in orde r to isol a te our p robl e m.
I
(I) La bour is p e rf e ctl y h omoge ne ous. Al l me n a re a l ike , a nd e a ch (wh e n e mp l oy e d)
p e rf orms a re gul a r numbe r of h ours' work ove r a y e a r.
(2) La nd, incl uding a l l non-p roduce d. me a ns of p roduction, is h omoge ne ous.
T h is invol ve s th a t th e re a re no sp e cia l ise d f a ctors of p roduction such a s p a rticul a r
kinds of soil or mine ra l de p osits, a nd no inf l ue nce of ge ogra p h y up on p roduction.
(3) Al l h ouse h ol ds consume commoditie s in th e sa me p rop ortions, irre sp e ctive of
ch a nge s in th e ir re l a tive p rice s ; dif f e re nce s in a ve ra ge income p e r h e a d a nd in th e
distribution of income be twe e n individua l s h a ve no e f f e ct up on th e comp osition of
de ma nd f or f ina l outp ut. We ca n th e n me a sure outp ut simp l y in units of a comp osite
commodity , re p re se nting e a ch good in th e p rop ortion in wh ich it is be ing p roduce d.
In so f a r a s ne t inve stme nt is going on, ca p ita l goods a re re p re se nte d
in th e unit of
f ina l outp ut.'
(4)
T h e re a re no e conomie s or dise conomie s of sca l e f or outp ut a s a wh ol e or f or
p a rticul a r commoditie s.
I ca l l th e se a ssump tions th e trick a ssump tions, be ca use th e y a re onl y a sca re crow
to ke e p th e inde x numbe r birds of f our f ie l ds until a f te r th e h a rve st.
T h e re is a ce rta ina wkwa rdne ss in a ssuming th a t th e p rop ortionof ne t inve stme nt in tota l income is
inde p e nde ntof th e distributionof income , but th is dif f icul ty doe s not imp inge up onth e que stions th a t we
h a ve to discuss.
86 T HE REVIEW OF EC ONOMIC ST UDIES
II
T h e a rgume nt is conf ine d to a two-f a ctor e conomy , a nd a two-cl a ss socie ty .
(i) T o isol a te th e p robl e m of ca p ita l we a bstra ct f rom l a nd a nd a l l non-p roduce d
me a ns of p roduction. T h e " f re e gif ts of na ture " a re comp l e te l y f re e , p l e ntif ul a nd
una p p rop ria te d. Sp a ce a nd a ir a re ne ce ssa ry to p roduction, but ne ith e r comma nds
a p rice .
(2) We rul e out a sse ts, such a s th e goodwil l of a busine ss, wh ich a re we a l th to a n
individua l but not to socie ty ; we me a n by ca p ita l p h y sica l p roductive re source s,
wh ich woul d h a ve th e sa me signif ica nce in a n a rtiza n, a ca p ita l ist a nd a socia l ist
e conomy .
(3)
T o e l imina te th e inf l ue nce of th e e ntre p re ne ur, we a ssume th a t e conomie s of
sca l e inte rna l to a p roductive unit a re e xh a uste d, in e a ch l ine of p roduction, a t a
mode ra te ra te of outp ut, a nd th a t a n e xp e rie nce d e ntre p re ne ur h a s no a dva nta ge
ove r a ne w h a nd. T h e know-h ow of p roduction is wide l y dif f use d a nd dif f e re nce s in
skil l of ma na ge me nt a re unimp orta nt. T h e onl y qua l if ica tion re quire d f or e mp l oy ing
l a bour is th e n th e owne rsh ip of suf f icie nt ca p ita l (or comma nd of suf f icie nt cre dit) to
se t up a p roductive unit of th e minimum size . (T h e a ssump tion of no e conomie s of
sca l e ( I, 2 ) a p p e a rs h e re a s we l l a s in th e sca re crow.) In th e se conditions, th e distinction
be twe e n inte re st a nd p rof it ce a se s to be signif ica nt. T h e re is no sp e cif ic " re wa rd of
e nte rp rise " a p a rt f rom th e re wa rd of owning ca p ita l , a nd no owne r of ca p ita l wil l
p rovide f ina nce f or a n e ntre p re ne ur a t a p p re cia bl y l e ss th a n th e ra te of p rof it wh ich
h e ca n e xp e ct to obta in by using h is ca p ita l h imse l f to e mp l oy l a bour. T h us in our
sy ste m, p rof its a nd wa ge s e xh a ust tota l ne t income .
T h e size of individua l p roductive units, a bove th e te ch nica l minimum, is not
strictl y l imite d in th e l ong run, but th e re is no p a rticul a r p re ssure towa rds a growth
in size , a nd, wh e n th e tota l a mount of ca p ita l is a ccumul a ting, th e numbe r of inde -
p e nde nt ca p ita l ists is conce ive d to mul tip l y more or l e ss in p rop ortion to th e a mount
of ca p ita l ; th e a ve ra ge sca l e on wh ich th e y op e ra te is more or l e ss consta nt, a t a size
wh ich is sma l l in re l a tion to th e ma rke ts sup p l ie d, so th a t conditions of a tomistic
comp e tition ca n p re va il . (T h e minimum size of a p roductive unit is, h owe ve r, l a rge
e nough to ma ke it ve ry dif f icul t f or a worke r to be come a ca p ita l ist, so th a t th e sy ste m
doe s not re l a p se into a n e conomy of a rtiza ns.)
III
We ca l l th e stock of goods in e xiste nce a t a ny mome nt p h y sica l ca p ita l . T h e
va l ue of th e se goods in te rms of a unit of outp ut we ca l l ca p ita l simp l icite r. C a p ita l
va l ue d in te rms of wa ge units we ca l l re a l ca p ita l ; th ough it must be obse rve d th a t
th e re is a sl igh tl y misl e a ding f l a vour a bout th is te rm, since th e cost of ca p ita l goods,
in te rms of wa ge units, incl ude s inte re st ove r th e time re quire d to construct th e m a nd
to use th e m in p roduction. T h us th e sa me stock of p h y sica l goods re p re se nts a l a rge r
a mount of re a l ca p ita l wh e n th e ra te of inte re st is h igh e r (a nd h a s be e n h igh e r in th e
p a st) th a n wh e n it is (a nd h a s be e n) l owe r.
We ca l l th e ra tio of re a l ca p ita l to ma n h ours of curre nt e mp l oy me nt p e r a nnum
th e f a ctor ra tio.
We ta ke a s th e wa ge unit th e p rice of a n h our's l a bour in te rms of th e comp osite
unit of p roduct, no ma tte r wh e th e r th e worke r wh o p e rf orms a n h our's work is p a id
in ca sh or in p e a nuts." In wh a t f ol l ows we me a n by " wa ge s," th e cost of l a bour to
1
Wh e n Mr. (now Prof e ssor) Hicks e l imina te d th e e qua tion f or mone y f rom th e n +
X
va l ue e qua tions
f or n commoditie s, Mr. Le rne r re ma rke d,
"
If I e l imina te th e e qua tion f or p e a nuts, wh a t th e n ? " I ta ke
p e a nuts a s a n e xa mp l e of a commodity ch ose n a t ra ndom, in a l l usion to th is e xtre me l y sa p ie nt contribution
to th e p ure th e ory of va l ue .
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 87
th e e mp l oy e r, in te rms of p roduct. Wh e n we h a ve occa sion to re l a x th e trick a ssump -
tions a nd to l ook a t wa ge s f rom th e p oint of vie w of worke rs re ga rde d a s consume rs,
we ca l l th e p urch a sing p owe r of th e wa ge a worke r ge ts h is re a l wa ge . T h us we a re
using th e " re a l wa ge ra te " in its common or ga rde n se nse , a nd th e " wa ge ra te "
simp l icite r in a sp e cia l se nse .
LONG-PERIOD EQUILIBRIUM
Our a rgume nt tre a ts of th e re l a tions be twe e n qua ntitie s of f a ctors of p roduction
in e xiste nce . It ca nnot ta ke into its p urvie w th e disturba nce s a rising f rom th e p roce ss
of ch a nging th e qua ntitie s of f a ctors. We must, th e re f ore , rul e out a l l p robl e ms of
e f f e ctive de ma nd a nd conf ine our a rgume nt to p ositions of e quil ibrium. Wh a t doe s
th is imp l y ?
One notion of e quil ibrium is th a t it is re a ch e d (with a consta nt l a bour f orce ) wh e n
th e stock of ca p ita l a nd th e ra te of p rof it a re such th a t th e re is no motive f or f urth e r
a ccumul a tion. T h is is a ssocia te d with th e ide a of a n ul tima te th orough -going sta tiona ry
sta te ,' in wh ich th e ra te of p rof it is e qua l to th e " sup p l y p rice of wa iting." In th is
situa tion a n a ccide nta l incre a se in th e stock of ca p ita l a bove th e e quil ibrium qua ntity
woul d de p re ss th e ra te of p rof it be l ow th is sup p l y p rice , a nd ca use th e a dditiona l
ca p ita l to be consume d ; wh il e a ny re duction woul d ra ise th e ra te of p rof it, a nd ca use
th e de f icie ncy to be ma de good. Equil ibrium p re va il s wh e n th e stock of ca p ita l is
such th a t th e ra te of p rof it is e qua l to th e sup p l y p rice of th a t qua ntity of ca p ita l .
But th is notion is a ve ry tre a ch e rous one . Wh y sh oul d th e sup p l y p rice of wa iting
be a ssume d p ositive ? In Ada m Smith 's f ore st th e re wa s no p rop e rty in ca p ita l a nd
no p rof it (th e me a ns of p roduction, wil d de e r a nd be a ve rs, we re p l e ntif ul a nd un-
a p p rop ria te d). But th e re migh t stil l be wa iting a nd inte re st. Sup p ose th a t some
h unte rs wish to consume more th a n th e ir kil l , a nd oth e rs wish to ca rry consuming
p owe r into th e f uture . T h e n th e l a tte r coul d l e nd to th e f orme r to-da y , out of to-da y 's
ca tch , a ga inst a p romise of re p a y me nt in th e f uture . T h e ra te of inte re st (e xce ss of
re p a y me nt ove r origina l l oa n) woul d se ttl e a t th e l e ve l wh ich e qua te d sup p l y a nd
de ma nd f or l oa ns. Wh e th e r it wa s p ositive or ne ga tive woul d de p e nd up on wh e th e r
sp e ndth rif ts or p rude nt f a mil y me n h a p p e ne d to p re domina te in th e community .
T h e re is no a p riori p re sump tion in f a vour of a p ositive ra te . T h us th e ra te of inte re st
ca nnot be a ccounte d f or a s th e " cost of wa iting ".
T h e re a son wh y th e re is a l wa y s a de ma nd f or l oa ns a t a p ositive ra te of inte re st,
in a n e conomy wh e re th e re is p rop e rty in th e me a ns of p roduction a nd me a ns of p ro-
duction a re sca rce , is th a t f ina nce e xp e nde d now ca n be use d to e mp l oy l a bour in
p roductive p roce sse s wh ich wil l y ie l d a surp l us in th e f uture ove r costs of p roduction.
Inte re st is p ositive be ca use p rof its a re p ositive (th ough a t th e sa me time th e cost a nd
dif f icul ty of obta ining f ina nce p l a y a p a rt in ke e p ing p roductive e quip me nt sca rce , a nd
so contribute to ma inta ining th e l e ve l of p rof its).
Wh e re th e " sup p l y p rice of wa iting" is ve ry l ow or ne ga tive , th e ul tima te
sta tiona ry e quil ibrium ca nnot be re a ch e d until th e ra te of p rof it h a s f a l l e n e qua l l y l ow,
ca p ita l h a s ce a se d to be sca rce a nd ca p ita l ism h a s ce a se d to be ca p ita l ism.
T h e re f ore
th is ty p e of e quil ibrium is not worth discussing.
T h e oth e r wa y of a p p roa ch ing th e jue stion is simp l y to p ostul a te th a t th e stock
of ca p ita l in e xiste nce a t a ny mome nt is th e a mount th a t h a s be e n a ccumul a te d up to
da te , a nd th a t th e re a son wh y it is not l a rge r is th a t it ta ke s time to grow. T h is is th e
conce p tion wh ich is a dop te d in th is e ssa y . At a ny mome nt th e re is a ce rta in stock of
ca p ita l in e xiste nce . If th e ra te of p rof it a nd th e de sire to own more we a l th a re such
' Pigou, T h e Economics of Sta tiona ry Sta te s.
88 T HE REVIEW OF EC ONOMIC ST UDIES
a s to induce a ccumul a tion, th e stock of ca p ita l is growing a nd, p rovide d th a t l a bour
is- a va il a bl e or p op ul a tion growing, th e sy ste m is in p roce ss of e xp a nding with out a ny
disturba nce to th e conditions of e quil ibrium. (If two sna p sh ots we re ta ke n of th e
e conomy a t two dif f e re nt da te s, th e stock of ca p ita l , th e a mount of e mp l oy me nt a nd
th e ra te of outp ut woul d a l l be l a rge r, in th e se cond p h otogra p h , by a ce rta in p e rce nta ge ,
but th e re woul d be no oth e r dif f e re nce .) If th e stock of ca p ita l is be ing ke p t consta nt
ove r time , th a t is me re l y a sp e cia l ca se in wh ich th e ra te of a ccumul a tion h a p p e ns to
be ze ro. (T h e two sna p sh ots woul d th e n be indistinguish a bl e .)
In th e inte rna l structure of th e e conomy conditions of l ong-p e riod e quil ibrium a re
a ssume d to p re va il . Ea ch ty p e of p roduct se l l s a t its norma l l ong-run sup p l y p rice .
For a ny one ty p e of commodity , p rof it, a t th e ra te rul ing in th e sy ste m a s a wh ol e ,
on th e cost of ca p ita l e quip me nt e nga ge d in p roducing it, is p a rt of th e l ong-run sup p l y
p rice of th e commodity , f or no commodity wil l continue to be p roduce d unl e ss ca p ita l
inve ste d f or th e p urp ose of p roducing it y ie l ds a t l e a st th e sa me ra te of p rof it a s th e
re st. (It is a ssume d th a t ca p ita l ists a re f re e to move f rom one l ine of p roduction to
a noth e r.) T h us th e " costs of p roduction " wh ich de te rmine sup p l y p rice consist of
wa ge s a nd p rof its. In th is conte xt th e notion of a qua ntity of ca p ita l p re se nts no
dif f icul ty , f or, to a ny one ca p ita l ist, ca p ita l is a qua ntity of va l ue , or ge ne ra l ise d p ur-
ch a sing p owe r, a nd unde r our trick a ssump tions, in a give n e quil ibrium situa tion, a
unit of a ny commodity ca n be use d a s a me a sure of p urch a sing p owe r.
Since th e sy ste m is in e quil ibrium in a l l its p a rts, th e rul ing ra te of p rof it is be ing
obta ine d on ca p ita l wh ich is be ing use d to p roduce ca p ita l goods, a nd e nte rs into th e ir
" cost of p roduction ". Prof it on th a t p a rt of th e cost of ca p ita l re p re se nte d by th is
p rof it is th e n a comp one nt of th e " cost of p roduction
"
of f ina l outp ut. A ca p ita l ist
wh o buy s a ma ch ine re a dy ma de p a y s a p rice f or it wh ich incl ude s p rof it to th e ca p ita l ist
wh o se l l s it. T h e p rof it a ca p ita l ist wh o h a s th e ma ch ine buil t in h is own worksh op s
wil l e xp e ct to re ce ive , f rom sa l e s of th e f ina l outp ut, incl ude s p rof it on th e inte re st (a t
a notiona l ra te e qua l to th e rul ing ra te of p rof it) on th e cost of h a ving th e ma ch ine
buil t re ckone d ove r th e p e riod of construction. For wh e n h e buil ds th e ma ch ine h im-
se l f h e h a s a l onge r wa iting p e riod be twe e n sta rting to inve st a nd re ce iving th e f irst
p rof it. If h e coul d not e a rn p rof it on th e notiona l inte re st cost, h e woul d p re f e r to
ma ke a n inve stme nt wh e re th e re wa s a sh orte r wa iting p e riod, so th a t h e coul d re ce ive
a ctua l p rof it e a rl ie r. T h e a ctua l p rof it h e coul d p l ough into inve stme nt; th us a cquiring
(ove r th e sa me wa iting p e riod) th e sa me qua ntity of ca p ita l a s in th e ca se wh e re h e
buil ds th e ma ch ine f or h imse l f . (He woul d a l so h a ve th e a dva nta ge th a t h e coul d
ch a nge h is mind a nd consume th e p rof it, wh e re a s in th e f irst ca se h e is committe d to
th e wh ol e sch e me of inve stme nt once h e be gins.) T h us inve stme nts with a l ong
ge sta tion p e riod wil l not be ma de unl e ss th e y a re e xp e cte d to y ie l d a p rof it on th e
e l e me nt of ca p ita l cost re p re se nte d by comp ound inte re st ove r th e ge sta tion p e riod
(if th e re we re unce rta inty , th e y woul d h a ve to be e xp e cte d to y ie l d more , to com-
p e nsa te f or th e gre a te r rigidity of th e inve stme nt p l a n).
We ne e d not go ba ck to Ada m to se a rch f or th e f irst p ure unit of l a bour th a t
contribute d to th e construction of e xisting e quip me nt. T h e ca p ita l goods in be ing
to-da y h a ve mutua l l y contribute d to p roducing e a ch oth e r, a nd e a ch is a ssume d to
h a ve re ce ive d th e a p p rop ria te a mount of p rof it f or doing so.
So much f or th e sup p l y p rice of a n ite m of ne w e quip me nt. How a re we to re ckon
th e sup p l y p rice of p a rt-worn e quip me nt ? Inve stme nt in ne w e quip me nt is not ma de
unl e ss its gross e a rnings (e xce ss of outp ut ove r wa ge s bil l in te rms of outp ut) a re
e xp e cte d to be suf f icie nt to a mortise th e inve stme nt ove r its working l if e , a l l owing f or
inte re st a t th e rul ing ra te on a ccrue d a mortisa tion f unds, a s we l l a s p roviding p rof it
a t th e rul ing ra te . T h e sup p l y p rice of a n e quip me nt wh ich h a s be e n working f or a
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL
89
ce rta in time
ma y
be
re ga rde d
a s its initia l cost a ccumul a te d
up
to da te a t
comp ound
inte re st, minus its
gross e a rnings
a l so a ccumul a te d f rom th e da te s a t wh ich
th e y
a ccrue d
up
to th e
p re se nt,
f or th is
corre sp onds
to th e
e xp e cta tions
wh ich induce d
ca p ita l ists
in th e
p a st
to ma ke th e inve stme nt conce rne d.
Since initia l cost is incurre d a t th e
be ginning,
a nd
e a rnings
a ccrue ove r time , th e
e l e me nt of inte re st on cost in th e a bove ca l cul a tion e xce e ds th e e l e me nt of inte re st on
e a rnings.
T h us wh e n a n
e quip me nt
h a s
y ie l de d
a
qua rte r
of its
e xp e cte d
tota l
e a rnings,
its
sup p l y p rice ,
in th is se nse , is some wh a t more th a n
th re e -qua rte rs
of its initia l
cost;
h a l f -wa y th rough ,
some wh a t more th a n h a l f its initia l cost, a nd so f orth ,
th e dif f e re nce
a t
a ny
mome nt
be ing l a rge r
th e
h igh e r
th e ra te of inte re st. Ove r its l if e th e a ccumul a te d
inte re st on its
e a rnings,
so to
sa y ,
ca tch e s
up up on
th e a ccumul a te d inte re st on its
cost, so th a t a t th e e nd of its l if e it is
f ul l y p a id
of f a nd its
sup p l y p rice (a bstra cting
f rom
scra p
va l ue )
h a s f a l l e n to ze ro.
T h e va l ue of a n
e quip me nt de p e nds up on
its
e xp e cte d
f uture
e a rnings.
It
ma y
be
re ga rde d
a s f uture
e a rnings
discounte d ba ck to th e
p re se nt
a t a ra te
corre sp onding
to th e
rul ing
ra te of inte re st. In
e quil ibrium
conditions th e
sup p l y p rice
(in
th e a bove
se nse )
a nd th e va l ue of a n
e quip me nt
a re
e qua l
a t a l l
sta ge s
of its l if e .'
Equil ibrium re quire s
th a t th e stock of ite ms of
e quip me nt op e ra te d by
a l l th e
ca p ita l ists p roducing
a
p a rticul a r commodity
is
continuousl y be ing
ma inta ine d. T h is
e nta il s th a t th e
a ge comp osition
of th e stock of
e quip me nt
is such th a t th e a mortisa tion
f unds
p rovide d by
th e stock a s a wh ol e a re
be ing continuousl y sp e nt
on
re p l a ce me nts.
Wh e n th e stock of
e quip me nt
is in ba l a nce th e re is no ne e d to
e nquire
wh e th e r a
p a rticul a r
worke r is
occup ie d
in
p roducing
f ina l
outp ut
or in
re p l a cing p l a nt.
T h e
wh ol e of a
give n
l a bour f orce is
p roducing
a stre a m of f ina l
outp ut
a nd a t th e sa me
time
ma inta ining
th e stock of
e quip me nt
f or f uture
p roduction.
Nor is it
ne ce ssa ry
to
inquire
wh a t
book-ke e p ing
me th ods a re use d in
re ckoning
a mortisa tion
quota s.
T h e se
a f f e ct th e re l a tions be twe e n individua l
ca p ita l ists,
but ca nce l out f or th e
group
a s a
wh ol e .
In
e quil ibrium
th e
a ge
comp osition
of th e stock of
e quip me nt
is sta bl e , but th e
tota l stock
ma y
be in course of
e xp a nding.
T h e
a ve ra ge a ge
of th e
p l a nts ma king up
a ba l a nce d stock of sta bl e
a ge comp osition
va rie s with th e
l e ngth
of l if e of individua l
p l a nts.
If th e tota l stock is
re ma ining
consta nt ove r time ,
th e
a ve ra ge
a ge
is
e qua l
to
h a l f th e
l e ngth
of l if e . If th e stock h a s be e n
growing
th e
p rop ortion
of
y ounge r p l a nts
is
gre a te r
a nd
a ve ra ge
a ge
is l e ss th a n h a l f th e l if e
sp a n.
(T h e re
is a n e xa ct
a na l ogy
with th e
a ge comp osition
of a sta bl e
p op ul a tion.)
T h e a mount of
ca p ita l
e mbodie d in a stock of
e quip me nt
is th e sum of th e
sup p l y
p rice s (re ckone d
a s
a bove )
of th e
p l a nts
of wh ich it is
comp ose d,
a nd th e ra tio of th e
a mount of
ca p ita l
to th e sum of th e costs of th e
p l a nts
wh e n e a ch wa s bra nd ne w is
h igh e r
th e
gre a te r
th e ra te of inte re st.2
1
T h e
e qua l isa tion
of th e va l ue of two a nnuitie s a t a ny p oint
of time e nta il s th e ir
e qua l isa tion
a t a ny
oth e r
p oint
of time . If th e cost of a ne w ma ch ine is
e qua l , a t th e mome nt wh e n it is bra nd ne w, to th e
discounte d va l ue of its
e xp e cte d gross e a rnings,
it f ol l ows th a t, a t
a ny
l a te r
p oint
of time , th e a ccumul a te d
va l ue of th e
origina l
cost a nd
gross e a rnings up
to da te wil l , if
e xp e cta tions
h a ve be e n
p rove d
corre ct
up
to da te a nd a re una f f e cte d f or th e f uture , be
e qua l to th e
p re se nt
va l ue of th e
re ma ining gross e a rnings
e xp e cte d
ove r th e f uture . C f . Wickse l l ,
"
Re a l
C a p ita l a nd Inte re st," Le cture s (Engl ish
e dition),
Vol . I,
p .
276.
2
T h e orde r of
ma gnitude
of th e inf l ue nce of th e ra te of inte re st is sh own
by
th e f ormul a
p rovide d
in
th e Ma th e ma tica l Adde ndum
by D. G.
C h a mp e rnowne
a nd R. F. Ka h n. For th is f ormul a it is
ne ce ssa ry
to a ssume
(a )
th a t th e tota l stock of
ca p ita l
is consta nt ove r time ,
(b)
th a t
e a rnings
a re a t a n e ve n ra te ove r
th e l if e of th e
p l a nt. C is th e
ca p ita l
va l ue of a n inve stme nt, K th e initia l
outl a y , r th e ra te of inte re st a nd
T th e
p e riod
ove r wh ich th e a sse t e a rns. For va l ue s of rT l e ss th a n 2 we use th e
a p p roxima tion C /K-
=
i (I + * rT ).
On th is
ba sis,
wh e n th e ra te of inte re st
is,
f or
e xa mp l e ,
6
p e r
ce nt,
a ma ch ine of te n
y e a rs'
l if e
costing
o100 wh e n ne w must e a rn
13.3 p e r
a nnum
surp l us
ove r th e curre nt
outl a y
on
working
it
(incl uding
curre nt
re p a irs).
T h e
y ie l d
wil l th e n be 6
p e r
ce nt on a
ca p ita l
va l ue of
55.
(C ontinue dore rl e a f .)
T HE REVIEW OF EC ONOMIC ST UDIES
Equil ibrium re quire s
th a t th e ra te of
p rof it rul ing to-da y
wa s
e xp e cte d
to be
rul ing to-da y
wh e n inve stme nt in
a ny p l a nt
now e xta nt wa s
ma de , a nd th e
e xp e cta tion
of f uture
p rof its obta ining to-da y
wa s
e xp e cte d
to obta in
to-da y .
T h us th e va l ue of
ca p ita l
in e xiste nce
to-da y
is
e qua l
to its
sup p l y p rice
ca l cul a te d in th is ma nne r. T h e
h e a vy we igh t
wh ich th is me th od of
va l uing ca p ita l p uts up on
th e
a ssump tions
of
e quil ibrium e mp h a sise s
th e
imp ossibil ity
of
va l uing ca p ita l
in a n unce rta in worl d. In a
worl d wh e re
une xp e cte d
e ve nts occur wh ich a l te r va l ue s, th e
p oints
of vie w of th e
ma n of
de e ds, ma king
inve stme nt de cisions a bout th e f uture , a nd of th e ma n of words
ma king
obse rva tions a bout th e
p a st,
a re irre concil a bl e , a nd a l l we ca n do is botch
up
some conve ntiona l me th od of
me a suring ca p ita l
th a t wil l
sa tisf y
ne ith e r of th e m.
T HE
T EC HNIQUE
OF PRODUC T ION
How ca n we re duce th e
a morp h ous conce p tion
of a " sta te of te ch nica l
knowl e dge "
to de f inite te rms ? Le t us
sup p ose
th a t f or
a ny give n
l ine of
p roduction,
we ca n dra w
up
a l ist of a ctua l
te ch nique s
wh ich coul d be use d, with a
give n
a mount of curre nt
l a bour, to
p roduce
a f l ow of
outp ut
of th e
commodity conce rne d,
wh il e
ma inta ining
th e
p roductive e quip me nt re quire d
inta ct. Ea ch
te ch nique
is conce ive d to be
sp e cif ie d
in de ta il , a nd e nta il s th e use of
p a rticul a r
ite ms of
e quip me nt
a nd a
p a rticul a r qua ntity
of
work-in-p rogre ss
in th e
p roductive p ip e
l ine . Oth e r
th ings e qua l ,
a
te ch nique
invol ving
a
l onge r p roduction p e riod
(f rom
cl ip p ing
th e
sh e e p
to
se l l ing
th e
ove rcoa t)
re quire s
a
l a ge r
run-out of ma n h ours e mbodie d in
work-in-p rogre ss.
T h is is tre a te d
a s
p a rt
of th e stock of
ca p ita l goods re quire d by
th is
te ch nique .1
We th e n
a ma l ga ma te
th e l ists f or
p a rticul a r
commoditie s in such a
wa y
a s to
ge t
a f l ow of
outp ut
of com-
moditie s in th e
p rop ortions
dicta te d
by
th e
a ssump tion
th a t th e
comp osition
of f ina l
outp ut
is
give n.
We th us h a ve a se t of bl ue
p rints
of
te ch nique s,
e a ch of wh ich coul d
be use d to
e mp l oy
a
give n
a mount of l a bour to
p roduce
a f l ow of
outp ut.
T h e
te ch nique s
a re l iste d in a
h ie ra rch y , Al p h a , Be ta , e tc., a ccording
to th e ra te
of
outp ut
wh ich
th e y p roduce
with a
give n
numbe r of me n.
(T h e
numbe r of me n must
be a common
mul tip l e
of th e numbe rs
re quire d by
a se l f -conta ine d unit of e a ch te ch -
nique ,
to a void " a
ra gge d e dge
"
wh e n worke rs a re a l l otte d to
p l a nts.)
T h e inte rna l
de scrip tion
of a
give n te ch nique
is a
p ure l y e ngine e ring que stion,
but th e l ist of
te ch nique s
ca nnot be dra wn
up
in
p ure l y e ngine e ring te rms,
with out
A
ca p ita l ist
wh o
op e ra te s
such a ma ch ine
ma y
a mortise th e initia l inve stme nt
by p a y ing Lio e ve ry
y e a r
into a
sinking
f und.
Re ckoning
a t
simp l e
inte re st
onl y ,
h e re ce ive s inte re st on th e a mortisa tion f und
a f te r one
y e a r
of o.6 ; in th e sixth
y e a r L3
;
in th e l a st
y e a r 5.4.
T h us th e a nnua l re turn on h is inve stme nt
of 1ioo rise s ove r th e te n
y e a r p e riod
f rom
a p p roxima te l y L3
to
a p p roxima te l y
9
(th e
"
ra gge d e dge
"
is
due to
re ckoning
th e a mortisa tion
quota
a s
p a id
a t th e e nd of a
y e a r,
a nd
re ckoning
inte re st a s
p a id a nnua l l y
inste a d of
continuousl y ).
T h e undiscounte d
a ve ra ge
a nnua l income is, th e re f ore , 6 (6 p e r
ce nt on th e
initia l
outl a y ).
C omp ound
inte re st ove r th e
p e riod comp e nsa te s
f or
discounting
th is income . Ove r th e
l if e
h istory
of th e ma ch ine ,
th e f a l l in
ca p ita l
va l ue f rom 10ooto ze ro is in
ste p
with th e rise in th e a mortisa -
tion f und.
A group
of te n such ma ch ine s of
a ge s
ze ro to nine
y e a rs
h a ve a
p a tte rn
of va l ue s,
a t
a ny
mome nt,
wh ich
corre sp onds
to th e
p a tte rn
ove r time of a
singl e
ma ch ine . It
re quire s
a n a nnua l
outl a y
on re ne wa l s
of ioo
p e rma ne ntl y
to ma inta in th e stock of ma ch ine s.
T h e y re p re se nt
a
ca p ita l
va l ue of
55o
a nd
y ie l d
a re turn of
33
p e r
a nnum.
If th e ra te of inte re st we re io
p e r
ce nt,
rT woul d be
e qua l
to i a nd th e
ca p ita l
va l ue
(a bstra cting
f rom
a
h igh e r
initia l cost of ma ch ine s due to th e
h igh e r
inte re st
ra te )
woul d be
583;
th e
e a rnings
of e a ch
ma ch ine woul d th e n h a ve to be
15.8
to
y ie l d
th e
re quire d
ra te of
p rof it.
If th e
l e ngth
of l if e of ma ch ine s wa s
twe nty y e a rs,
a nd th e ra te of inte re st
5 p e r
ce nt,
ca p ita l
va l ue
woul d a ga in be
583,
a nd e a ch ma ch ine woul d h a ve to
y ie l d L7.9 p e r
a nnum
(5
f or a mortisa tion a nd
2.9
f or
inte re st);
a t io
p e r ce nt,
rT woul d be
e qua l
to 2;
th e
ca p ita l
va l ue woul d th e n be
666,
a nd e a ch ma ch ine
woul d h a ve to
y ie l d 11.7
p e r
a nnum.
1
T h is
wa y
of
l ooking
a t
th ings
is e a sie r to unde rsta nd th a n
a p p l y ing
th e notion of th e
"
l e ngth
of th e
p e riod
of
p roduction
"
to
l ong-l ive d e quip me nt.
It is h a rd to tre a t, sa y ,
a l oom a s a
l e ngth
of time ,
but
p e rf e ctl y e a sy
to
re ga rd
a
qua ntity
of
wool ,
a
qua ntity
of
y a rn
a nd a
qua ntity
of cl oth a s
p a rt
of th e
p h y sica l
e quip me nt re quire d
f or
p roducing
a
ste a dy
f l ow of
outp ut
of ove rcoa ts.
9o
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 9x
re ga rd to e conomic conside ra tions. (From a n e ngine e ring p oint of vie w, it is p ossibl e
to use a ste a m h a mme r f or cra cking nuts.) We must th e re f ore comp a re th e costs of
th e e quip me nts re quire d by va rious te ch nique s in orde r to be sure th a t we a re nowh e re
using more ca p ita l to p roduce l e ss p roduct.'
T h e cost of a n e quip me nt ca n be re ckone d in wa ge units (th a t is, l a bour time ),
but it incl ude s a n a l l owa nce f or inte re st on costs incurre d in th e p a st to cre a te th e
stock of goods in e xiste nce to-da y (th is, a s we h a ve se e n, de p e nds p a rtl y up on th e time
ta ke n to construct ca p ita l goods a nd p a rtl y up on th e time ove r wh ich th e y a re use d).
T h us cost in wa ge units must be e xp re sse d a s a f unction of th e ra te of inte re st. Le t
us ima gine th a t we p roce e d by f irst ta king a ny re a sona bl e va l ue f or th e ra te of inte re st
f or a p re l imina ry run ove r th e f ie l d. T a ke a n outf it of e quip me nt a s a going conce rn,
with a l l its p ip e l ine s f ul l of work-in-p rogre ss, comp ose d of p l a nts of th e a ge distribution
a p p rop ria te to th e ra te (wh ich ma y be ze ro) a t wh ich th e tota l stock of ca p ita l is
e xp a nding. Now ima gine th a t our notiona l ra te of inte re st re p re se nts th e ra te of
p rof it on ca p ita l a ctua l l y rul ing to-da y , a nd th a t th e sa me ra te of p rof it h a s be e n
rul ing a s l ong a s a ny ite m in th e stock of ca p ita l goods now e xta nt h a s be e n in e xiste nce .
T h e n we re ckon th e sup p l y p rice of th e e quip me nt a t th a t ra te of inte re st, a ssuming th a t
e a ch ite m in th e stock h a s be e n e a rning p rof its a t th a t ra te since it ca me into se rvice .
Wh e n th e e quip me nt re quire d by th e te ch nique s h a s be e n coste d in th is wa y ,
a ny te ch nique wh ich invol ve s a gre a te r cost th a n a noth e r f or th e sa me or a sma l l e r
ra te of outp ut is rul e d out, f or it is une conomic (a t th e a ssume d ra te of inte re st), h ow-
e ve r be a utif ul it ma y be f rom a n e ngine e ring p oint of vie w. T h e n a n Al p h a te ch nique
p roduce s a h igh e r ra te of outp ut with a give n a mount of l a bour, a nd invol ve s a gre a te r
cost of e quip me nt, th a n a Be ta te ch nique , Be ta a h igh e r outp ut a nd gre a te r cost of
e quip me nt th a n Ga mma , a nd so on down th e h ie ra rch y . We sh a l l de scribe th e Al p h a
te ch nique a s " more me ch a nise d " th a n th e Be ta te ch nique , a nd so on down th e l ist,
f or Al p h a invol ve s a gre a te r qua ntity of re a l ca p ita l (ca p ita l in te rms of p a st l a bour
inve ste d) p e r unit of l a bour curre ntl y e mp l oy e d, th a n doe s Be ta , a nd th is wil l nor-
ma l l y sh ow itse l f in a gre a te r comp l e xity of th e e quip me nt use d. In so f a r a s th e
a dva nta ge of th e sup e rior te ch nique l ie s in a l onge r l if e f or ite ms of e quip me nt, it
sh ows itse l f in a sma l l e r p rop ortion of th e give n l a bour f orce be ing occup ie d a t a ny
mome nt in re p l a ce me nt of ca p ita l goods. T h e conce p t of " me ch a nisa tion " is a l so
stre tch e d to cove r working ca p ita l . T h us, in th e f a mous e xa mp l e of th e wine ce l l a r, a
se t of ba rre l s one of e ve ry a ge f rom one to te n y e a rs is re ga rde d a s e quip me nt f or a
more me ch a nise d te ch nique th a n one consisting of ba rre l s of a ge s f rom one to nine
y e a rs (e a ch ce l l a r be ing te nde d by one nigh t wa tch ma n). But th is e xa mp l e is sop h istica -
te d by th e f a ct th a t th e outp ut of th e " more me ch a nise d " te ch nique is sup e rior in
qua l ity (th e a ge of th e wine re p re se nting f ina l outp ut), not qua ntity , to th a t of th e
"l e ss me ch a nise d."
We now re p e a t th e costings a t a l l ra te s of inte re st ove r a re a sona bl e ra nge . In
th e course of th is p roce ss we ma y cre a te ga p s in th e l ist of te ch nique s, or f ind ga p s
f orme rl y e xisting f il l e d up , a s th e notiona l ra te of inte re st a l te rs. For e xa mp l e , if th e
ma n-h ours re quire d to construct a p l a nt a p p rop ria te to Ga mma te ch nique a re sp re a d
ove r a l ong time , or a re h e a vil y conce ntra te d a t th e be ginning of th e ge sta tion p e riod,
wh il e th ose re quire d
to construct a Be ta p l a nt a re sp re a d ove r a sh ort time or a re
bunch e d ne a r th e mome nt of comp l e tion, or if a Ga mma p l a nt is more dura bl e , so
th a t th e a ve ra ge a ge of th e ite ms ma king up a ba l a nce d outf it of p l a nts is gre a te r, a
rise in th e ra te of inte re st ma y ra ise Ga mma 's cost a bove Be ta 's. But Ga mma 's ra te
1
T h is se e ms to h a ve be e n th e p oint th a t Ke y ne s h a d in mindwh e n h e comp a re dth e l e ngth ine ss of a
p roductive p roce ss to its sme l l ine ss. (Ge ne ra l T h e ory , p . 2I5.)
92 T HE REVIEW OF EC ONOMIC ST UDIES
of outp ut is l owe r. T h us a t th is notiona l ra te of inte re st Ga mma f a l l s out of th e
h ie ra rch y .'
T e ch nique s ma y a p p e a r or disa p p e a r in th e l ist a s th e notiona l ra te of inte re st
a l te rs, but two te ch nique s ca n ne ve r re ve rse th e ir p ositions, f or th e y we re l iste d in th e
f irst p l a ce in orde r of ra te s of outp ut with a give n a mount of curre nt l a bour, a nd th is
is a p ure l y e ngine e ring f a ct, inde p e nde nt of th e ra te of inte re st.
T h e dif f e re nce be twe e n a more a nd l e ss me ch a nise d te ch nique is not p roduce d by
a dding some sp oonf ul s of inve stme nt to a p ot-a u-f e u of " ca p ita l ". Ea ch te ch nique
invol ve s its own sp e cif ic bl ue p rints, a nd th e re ma y be no re cognisa bl e ite ms in common
be twe e n one a nd a ny oth e r. T h e re is, th e re f ore , no re a son wh y th e h ie ra rch y sh oul d
consist of sma l l ste p s in outp ut p e r ma n. It ma y do so, or it ma y consist of a se rie s of
jump s with a p p re cia bl e ga p s be twe e n e a ch te ch nique a nd th e ne xt. It se e ms obvious,
f or insta nce , th a t l a rge jump s occur be twe e n
te ch nique s
invol ving dif f e re nt source s
of p owe r.
T h e individua l ca p ita l ist is a ssume d to ch oose be twe e n p ossibl e te ch nique s in such
a wa y a s to ma ximise th e surp l us of outp ut th a t a give n a mount of ca p ita l y ie l ds ove r
wa ge s cost in te rms of h is own p roduct, a nd th us to obta in th e h igh e st ra te of p rof it
on ca p ita l th a t th e a va il a bl e te ch nique s ma ke p ossibl e .2
Give n th e h ie ra rch y of te ch nique s, th e h igh e r is th e wa ge ra te th e more me ch a nise d
is th e te ch nique wh ich is ch ose n. T h is p rincip l e is usua l l y de scribe d in a some wh a t
my stif y ing wa y in te rms of a " substitution of ca p ita l f or l a bour ' a s th e cost of l a bour
rise s. T h e osse ntia l p oint, h owe ve r, is ve ry simp l e . An Al p h a p l a nt invol ve s a gre a te r
ca p ita l cost a nd y ie l ds a h igh e r ra te of outp ut with a give n a mount of curre nt l a bour
th a n a Be ta p l a nt. At a h igh e r wa ge ra te both p l a nts y ie l d a sma l l e r p rof it p e r ma n
e mp l oy e d th a n a t a l owe r wa ge ra te , but a give n dif f e re nce in th e wa ge ra te re duce s
th e e xce ss of outp ut ove r wa ge s (th a t is, p rof it) in a sma l l e r p rop ortion wh e re outp ut
is h igh e r.
T h is ca n be il l ustra te d by me a ns of a crude nume rica l e xa mp l e , comp a ring th e
p rof ita bil ity of th re e te ch nique s a t two wa ge ra te s. T o ke e p th e a rith me tic simp l e we
ta ke ve ry l a rge dif f e re nce s be twe e n te ch nique s. T h e dif f e re nce in th e ca p ita l cost of
th e sa me p l a nt a t two dif f e re nt wa ge .ra te s is not p rop ortiona l to th e dif f e re nce in th e
wa ge ra te , f or a t a h igh e r wa ge th e re is a l owe r ra te of p rof it p re va il ing a nd conse -
que ntl y a sma l l e r e l e me nt of inte re st in cost. Aga in to ke e p th e e xa mp l e simp l e , we
a ssume th a t th e ca p ita l costs of th e th re e p l a nts a re a f f e cte d in th e sa me wa y by a
dif f e re nce in th e ra te of inte re st, so th a t th e ir re l a tive costs a re th e sa me a t both
wa ge ra te s.
At th e wa ge ra te of I p e r ma n, Ga mma a nd Be ta
te ch nique s y ie l d
th e sa me ra te
of p rof it, a nd Al p h a te ch nique a l owe r ra te . At th e wa ge i.i, Be ta a nd Al p h a y ie l d
th e sa me ra te of p rof it, a nd Ga mma a l owe r ra te (in f a ct, ze ro). T h us wh e n wa ge s
a re one unit of p roduct p e r ma n y e a r,
th e individua l ca p ita l ist is indif f e re nt be twe e n
Ga mma -a nd Be ta te ch nique -52 units of ca p ita l in te rms of va l ue
p urch a se
one Be ta
p l a nt y ie l ding a p rof it of io
p e r a nnum, or two Ga mma p l a nts y ie l ding 5 e a ch . (If
th e re we re a ny unce rta inty a bout f uture p rof its, th e Ga mma te ch nique woul d be
p re f e rre d, since a n inve stme nt wh ich is te ch nica l l y divisibl e is more f l e xibl e th a n one
wh ich is a n inte gra te d wh ol e .) Al p h a te ch nique
is out of th e
que stion. Simil a rl y ,
wh e n th e wa ge
ra te is
i.<,
Be ta a nd
Al p h a
a re indif f e re nt a nd Ga mma is out of th e
que stion.
1An e xa mp l e of th is p h e nome nonis il l ustra te din Fig.
I.
'For simp l icity of e xp ositionwe a re p ostul a ting inte gra te dp roduction, so th a t ra w ma te ria l s, p owe r,
e tc., bough t by one ca p ita l ist f rom oth e rs do not a p p e a ra s costs.
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL
93
Numbe r
of
Me n
p e r
Pl a nt:
50
Pl a nt
y
a
y
Wa ge
ra te .. i i I1.1 1.1 1.1
C a p ita l
.. 26 52
I04
27.5 55
IIo
Product .. 55 6o
65
55 6o
65
Wa ge bil l
..
50
50
50 55 55 55
Prof it .. ..
5
Io
I5
0
5
10
Ra te of Prof it
19% 19% I4%
0
9% 9%
(a p p roxima te )
In a n
e quil ibrium p osition
th e
te ch nique
of
p roduction th rough out
th e
e conomy
h a s be e n ch ose n
a ccording
to th is
p rincip l e ,'
a nd th e f a ctor ra tio
(re a l
ca p ita l p e r
ma n
e mp l oy e d), give n
th e te ch nica l
p ossibil itie s,
is
gove rne d by
th e
wa ge
ra te .
T HE RAT IO OF C APIT AL T O LABOUR
Wh e n th e
h ie ra rch y
of
te ch nique s
h a s be e n
sp e cif ie d
we ca n dra w a f a ctor-ra tio
curve
conne cting
re a l
ca p ita l p e r
ma n
e mp l oy e d
with th e ra te of
outp ut.
T h e re a de r
is wa rne d th a t it h a s a some wh a t biza rre
a p p e a ra nce comp a re d
to th e smooth
swe e p
of th e usua l te xt-book
p roduction
f unction.
FIG. I
OUT PUT
A
B
C
D
i I
I I I
I I I 11 I I
I I I II I I
I I I II I I
I
-
-
I
I IY4
I
I I I
I I I
I I I
I
I I
I I I
I I I
C tC t IiC 3,< 63 4-a s
4^a 4 `3
REAL C APIT AL
OA is th e ra te of
outp ut
of a consta nt numbe r of me n
using Al p h a te ch nique ,
OB th e
outp ut
with Be ta
te ch nique ,
OC with Ga mma
te ch nique ,
a nd OD with De l ta
te ch nique . Oa , is th e cost in te rms of
wa ge
units of a ba l a nce d outf it of
e quip me nt
1
For a
p ossibl e
ca se of
mul tip l e e quil ibrium se e
Ap p e ndix, p . o03
94
T HE REVIEW OF EC ONOMIC ST UDIES
re quire d by Al p h a te ch nique , ca l cul a te d a t a ce rta in ra te of inte re st, Oa 2 th e cost of
th e sa me e quip me nt a t a h igh e r ra te of inte re st, a nd so f or e a ch of th e te ch nique s a t
a sce nding inte re st ra te s.'
Howe ve r l a rge th e jump ma y be be twe e n one te ch nique a nd th e ne xt th e re is a
continuous re l a tionsh ip be twe e n outp ut p e r h e a d a nd th e f a ctor ra tio. Be twe e n, sa y ,
outp uts OC a nd OB, Ga mma a nd Be ta te ch nique s a re both be ing e mp l oy e d (a s in th e
nume rica l e xa mp l e , wh e n th e wa ge ra te wa s i) a nd be twe e n OB a nd OA, Be ta a nd
Al p h a te ch nique s a re both be ing e mp l oy e d (a s, in th e e xa mp l e , a t th e wa ge ra te of i.I).
A rise in th e f a ctor ra tio f rom Oc1 to
Obl ,
or f rom 0C 2 to 0b2, is due to a gra dua l incre a se
in th e p rop ortion of Be ta p l a nts in use , wh ich ca use s a rise in th e a ve ra ge of re a l ca p ita l
p e r ma n a nd a rise in a ve ra ge outp ut p e r h e a d.
T h us we ca n dra w, f or e a ch ra te of inte re st, a p roductivity curve , consisting of a
se rie s of stra igh t l ine s of ch a nging sl op e , wh ich e xh ibits th e rise of outp ut due to
a sce nding th e h ie ra rch y of te ch nique s.
Ea ch curve p urp orts to sh ow th e e ngine e ring ch a ra cte ristics of th e te ch nique s,
but it woul d be of no use to a sk a n e ngine e r h ow th e y sh oul d be dra wn. He doe s not
unde rsta nd th e me a ning of a give n sta te of te ch nica l knowl e dge , f or h e is l e a rning
some th ing f re sh e ve ry da y a s h e works.
"
Give n knowl e dge " is a dra stic a bstra ction
(th ough it ma y h a ve some re l e va nce f or a " ba ckwa rd " country wh ich ca n use a
surve y of p a st a nd p re se nt te ch nique s op e ra te d in
"
a dva nce d " countrie s a s a ca ta l ogue
of p ossibil itie s to ch oose f rom). It imp l ie s some a bsol ute up p e r l imit to th e ra te of
outp ut th a t a give n l a bour f orce ca n p roduce . Our curve s, th e re f ore , must be dra wn
with a ma ximum outp ut a s a n a sy mp tote a nd th e ir ge ne ra l sh a p e is conca ve to th e
x a xis2. T o a void comp l ica ting th e e xp osition we wil l p ostul a te th a t th e y a re conca ve
th rough out.3
T h e re l a tion be twe e n one curve a nd th e ne xt de p e nds up on th e re a ction of th e
cost of va rious outf its of e quip me nt to dif f e re nce s in th e ra te of inte re st, a nd th is
de p e nds, a s we h a ve se e n, in a comp l ica te d wa y , up on th e ge sta tion p e riod a nd l e ngth
of l if e of ite ms of e quip me nt. T h e re is l ittl e to be sa id a bout it a p riori,4 th ough it is
re a sona bl e to sup p ose th a t th e most me ch a nise d te ch nique s a re th e most se nsitive
to th e ra te of inte re st, so th a t th e f a mil y of curve s f a ns out l a te ra l l y a s it rise s.5
T h e da ta e mbodie d in th is sy ste m of curve s (if onl y we h a d a ny da ta !) p rovide a
comp l e te de scrip tion of a l l th e qua ntitie s of ca p ita l , va l ue d in wa ge units, wh ich ca n
be use d, in a give n sta te of knowl e dge , to e mp l oy a consta nt l a bour f orce .
Now, th e conditions of e quil ibrium re quire th a t th e ra te of inte re st wh ich e nte rs
into th e cost of e quip me nt is e qua l to th e ra te of p rof it a ctua l l y rul ing (f or th a t ra te
I
T o il l ustra te th e p oint ma de a bove , Ga mma te ch nique is sh own a s be coming une conomic a t th e
f ourth inte re st ra te .
2
T h is e xp re sse s
"
diminish ing re turns to ca p ita l
" a s th e ra tio of re a l ca p ita l to l a bour rise s. It is
imp orta nt not to conf use diminish ing re turns in th is se nse with th e C l a ssica l l a w of diminish ing re turns.
C l a ssica l diminish ing re turns a rise f rom a n incre a se of p op ul a tionre l a tive l y to consta nt na tura l
re source s,
wh ich ma y we l l corre sp ondto th e f a cts of l if e , wh e re a s th e diminish ing re turns sh own in th e p roduction
f unctiona re th e re sul t of th e a rtif icia l a ssump tionof a give n sta te of knowl e dge .
3
T h e re is no re a son, f rom a n e ngine e ring p oint of vie w, wh y th e y sh oul dnot be conve x ove r p a rticul a r
ra nge s, but if th e sl op e , sa y , be twe e n a y p oint a nd a , p oint is l e ss th a n th e sl op e be twe e n ,B a nd th e
corre sp onding a , it woul d indica te th a t th e incre a se in outp ut due to substituting a n Al p h a f or a Be ta
p l a nt woul d be more th a n p rop ortiona te to th e incre a se , a t a give n wa ge ra te , in th e cost of e quip me nt
invol ve d, so th a t Be ta te ch nique woul dne ve r be p rof ita bl e to use , T h is p ossibil ity is not rul e dout by th e
p roce ss of e l imina ting une conomic te ch nique s f rom th e curve s (se e p . 9I). E.g. in Fig. I, if
y , l a y
be twe e n th e p e rp e ndicul a r194b4 a nd th e l ine
84,B3,
th e Ga mma te ch nique
woul dnot h a ve be e n e l imina te d,
but th e curve
84Y4P4
woul dbe
conve x,
a nd th e re coul d be no
e quil ibrium
on th is se ction.
4
T h e Ma th e ma tica l Adde ndum indica te s th e l ine s onwh ich it woul dbe p ossibl e to work out th e inf l ue nce
of th e ra te of inte re st on th e cost of
e quip me nts h a ving va rious ch a ra cte ristics in re sp e ct to l e ngth of l if e ,
e tc. C f . p . 89, note 2.
6 For a "
p e rve rse
" ca se wh ich ma y occurwh e nth is is not true se e Ap p e ndix, p . Io6.
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 95
of p rof it h a s be e n rul ing ove r th e p e riod wh e n th e e xisting stock of ca p ita l goods wa s
be ing constructe d). We must, th e re f ore , ima gine th a t, by a p roce ss of tria l a nd e rror,
we f ind a p osition, f or e a ch f a ctor ra tio, wh e re th e two a re congrue nt. T h e p roductivity
curve , sa y s,
y .82a 2,
is dra wn up on th e ba sis of a ra te of inte re st e qua l to th e ra te of
p rof it wh ich woul d obta in if th e wa ge ra te we re such a s to ma ke Ga mma a nd Be ta
te ch nique s e qua l l y p rof ita bl e . T h e th ick l ine in th e dia gra m is th e f a ctor-ra tio curve .
At 72 th e f a ctor ra tio is OC 2, a nd a l l me n a re e mp l oy e d with Ga mma te ch nique .
An incre a se in th e f a ctor ra tio f rom 0C 2 towa rds Ob2 a nd a rise of outp ut f rom OC
towa rds OB woul d come a bout by substituting Be ta f or Ga mma p l a nts. Wh e n th e
f a ctor ra tio h a s rise n to Ob2 a l l worke rs a re e mp l oy e d with Be ta te ch nique , a nd outp ut
is OB. A f urth e r incre a se in th e f a ctor ra tio ca n come a bout onl y by th e introduction
of Al p h a p l a nts, but th is re quire s a rise in th e wa ge ra te a nd e nta il s a f a l l in th e ra te
of p rof it. We , th e re f ore , jump h orizonta l l y , f rom 2 to
P,
onto th e p roductivity curve
corre sp onding to th e ra te of p rof it wh ich obta ins wh e n th e wa ge ra te is such th a t
Al p h a a nd Be ta te ch nique s a re e qua l l y p rof ita bl e . T h e f a ctor ra tio incre a se s f rom
Ob1 to
Oa ,
by th e substitution of Al p h a f or Be ta p l a nts until , a t Oa 1 a l l me n a re e m-
p l oy e d with Al p h a te ch nique . A f urth e r incre a se in th e f a ctor ra tio th e n re quire s a
rise in th e wa ge ra te . And so on, up th e h ie ra rch y of te ch nique s, f rom one p roductivity
curve to a noth e r. At th e f ina l up p e r l imit, wh e re a f urth e r incre a se in th e f a ctor ra tio
ca nnot f urth e r incre a se outp ut p e r ma n, we re a ch th e sta te of Bl iss, wh e re wa ge s
a bsorb th e wh ol e p roduct a nd ca p ita l h a s ce a se d to be sca rce re l a tive l y to th e sta te
of knowl e dge .
T h e f ore going a na l y sis sh ows th a t th e re l a tion of ca p ita l to l a bour, in a n e quil i-
bnrum p osition, ca n be re ga rde d a s th e re sul ta nt of th e inte ra ction of th re e distinct
inf l ue nce s: th e wa ge ra te , th e ra te of inte re st a nd th e de gre e of me ch a nisa tion.
T h e inf l ue nce of th e wa ge ra te up on th e va l ue in te rms of p roduct of give n
p h y sica l ca p ita l wa s e mp h a sise d by Wickse l l ,1 a nd h a s be e n ca l l e d th e Wickse l l e f f e ct.2
Wh e n we re ga rd a stock of ca p ita l a s th e re sul t of a ccumul a tion brough t a bout by
sa ving-th a t is, re f ra ining f rom consuming income -we me a sure th e sa ving in te rms
of consump tion f orgone , a nd th e a ccumul a te d ca p ita l a s a sum of va l ue in te rms of
p roduct. T h e inf l ue nce of th e Wickse l l e f f e ct (l e a ving a side f or th e mome nt th e
inf l ue nce of inte re st on th e cost of ca p ita l goods) de te rmine s th e a mount of p h y sica l
ca p ita l wh ich a give n a mount of p a st a ccumul a tion h a s brough t into e xiste nce .
T h is inf l ue nce ca n be distinguish e d f rom th e e f f e ct of me ch a nisa tion by con-
side ring a ca se in wh ich th e re is onl y one te ch nique known. Sup p ose th a t to e mp l oy a
ma n re quire s a sp e cif ic se t of ca p ita l goods, -wh ich we ma y ca l l f or conve nie nce a
ma ch ine , th ough it incl ude s work-in-p rogre ss a s we l l a s l ong-l ive d e quip me nt. With out
just th is ma ch ine , a worke r ca n p roduce noth ing, a nd no oth e r kind of e quip me nt
h a s e ve r be e n th ough t of . T h e n comp a ring two situa tions in one of wh ich , Be ta -one ,
th e wa ge ra te is h igh e r th a n in th e oth e r, Be ta -two, a give n a mount of ca p ita l in
Be ta -one corre sp onds to a sma l l e r numbe r of ma ch ine s a nd p rovide s l e ss e mp l oy me nt
th a n in Be ta -two. T h is h a s e vide ntl y noth ing to do with a
"
substitution of ca p ita l
f or l a bour" f or, in a te ch nica l se nse , no substitution is p ossibl e .
T h e op e ra tion of th e Wickse l l e f f e ct is counte ra cte d by th e op e ra tion of th e inte re st
e f f e ct. A h igh e r wa ge ra te e nta il s a l owe r ra te of p rof it a nd, th e re f ore , in e quil ibrium,
re quire s th a t a l owe r ra te of inte re st h a s be e n rul ing in th e p a st. T h e cost of give n
p h y sica l ca p ita l in te rms of wa ge units is l e ss th e h igh e r th e wa ge ra te .3
1
Loc. cit., p . 292.
2
C . G. Uh r,
"
Knut Wickse l l . A C e nte nnia l Eva l ua tion," Amne rica nEconomic Re vie w, De ce mbe r, I951.
'T h is is sh own in th e dia gra m by th e ba ckwa rd jump of th e f a ctor-ra tio curve f rom
P,
to
f i,.
Se e a l so
Ap p e ndix.
96 T HE REVIEW OF EC ONOMIC ST UDIES
It is e vide ntl y p ossibl e th a t th e inte re st e f f e ct sh oul d a l so outwe igh th e Wickse l l
e f f e ct, so th a t th e va l ue of give n p h y sica l ca p ita l in te rms of p roduct is sma l l e r a t a
h igh e r wa ge ra te . T h is woul d occur if , f irst, th e cost of ca p ita l goods in te rms of wa ge
units re a cts strongl y to ch a nge s in th e ra te of inte re st (th e ir ge sta tion p e riod p l us th e ir
wor-king l if e is-l ong), a nd se cond, th e wa ge ra te is a l re a dy h igh re l a tive l y to outp ut
p e r ma n, so th a t a give n rise in th e wa ge ra te p roduce s a l a rge p rop ortiona te f a l l in
th e sh a re of p rof it in p roduct, a nd so in th e ra te of p rof it on ca p ita l .' Wh e re th e inte re st
e f f e ct more th a n of f se ts th e Wickse l l e f f e ct we se e th e a p p a re ntl y p a ra doxica l re sul t
th a t a give n a mount of ca p ita l (in te rms of p roduct) p rovide s a sma l l e r a mount of
e mp l oy me nt a t a l owe r th a n a t a h igh e r wa ge ra te .
T h e h igh e r f a ctor ra tio a ssocia te d in e quil ibrium with a h igh e r wa ge ra te , due
to th e use of more me ch a nise d te ch nique , h a s be e n ca l l e d th e " Rica rdo e f f e ct."2 T h e
a ttribution is some wh a t f orce d, y e t a l a be l is use f ul ; we ma y ca l l it th e Rica rde sque
e f f e ct.
A rise up th e h ie ra rch y of te ch nique s must be a ssocia te d with a rise in th e wa ge
ra te . But th e more ca p ita l (in te rms of a ccumul a te d p roduct) h a s be e n a bsorbe d by
incre a sing th e a mount of ma ch ine ry in e xiste nce , th e l owe r th e wa ge ra te a ssocia te d
with a give n a mount of a ccumul a tion. T h e more th e ca p ita l ists h a ve be e n a bl e to
ta ke a dva nta ge of th e Rica rde sque e f f e ct, th e l e ss th e worke rs h a ve be ne f ite d f rom
th e Wickse l l e f f e ct.
(Wh e n p rogre ss in te ch nica l knowl e dge is e conomising ca p ita l in te rms of a ccumu-
l a tion by incre a sing th e p roductivity of a give n a mount of re a l ca p ita l or wh e n op p or-
tunitie s f or me ch a nising p roduction stimul a te a ccumul a tion wh ich woul d not oth e rwise
occur, th e ca se is a l te re d. Our e quil ibrium conditions te l l us noth ing a bout th e e f f e ct
of inve ntions, or th e va ga rie s of e f f e ctive de ma nd.)
REAL NVAGES
T h e ne o-cl a ssica l sy ste m is ba se d on th e p ostul a te th a t, in th e l ong run, th e ra te
of re a l wa ge s te nds to be such th a t a l l a va il a bl e l a bour is e mp l oy e d. In sp ite of th e
a trocitie s th a t h a ve be e n committe d in its na me th e re is obviousl y a sol id core of
se nse in th is p rop osition. T o re turn to our roa d buil de rs, e mp l oy me nt p e r unit of
outp ut is much h igh e r in Ga mma th a n in Al p h a , a nd it se e ms obvious th a t th is is
conne cte d with th e f a ct th a t re a l wa ge s th e re a re much l owe r-th a t th e p l e th ora of
l a bour ke e p s re a l wa ge s down, a nd so h e l p s to ge t itse l f e mp l oy e d. Le t us try to se e
wh a t th is me a ns.
T h e ba sic da ta of our sy ste m a re : th e l a bour f orce , th e a mount of ca p ita l ,3 a nd
th e sta te of te ch nica l knowl e dge , e xp re sse d
a s th e h ie ra rch y , ra nge d a ccording to
de gre e s of me ch a nisa tion, of th e p ossibl e te ch nique s of p roduction. In orde r to sa tisf y
th e ne o-cl a ssica l p ostul a te of f ul l e mp l oy me nt, th e give n a mount of ca p ita l must
e mp l oy th e give n a mount of l a bour.
1
T h e nume rica l e xa mp l e on p . 89, note 2, sh ows th a t, on th e sta te d a ssump tions, a ve ry l a rge re duction
in th e ra te of inte re st, f rom io p e r ce nt to 6 p e r ce nt, re duce s th e sup p l y p rice of a give n ba l a nce d outf it of
e quip me nt, wh e n th e l if e of individua l ite ms is te n y e a rs, onl y in th e ra tio of 58 to 55 * with a l if e a s l ong a s
twe nty y e a rs, a re duction in th e ra te of inte re st f rom io p e r ce nt to 5 p e r ce nt re duce s sup p l y p rice in th e
ra tios of 66 to 58. T h is sugge sts th a t th e inte re st e f f e ct is not ve ry l a rge . On th e more re a l istic a ssump tion
th a t costs f or re p a irs rise with th e a ge of p l a nt, so th a t e a mings a re l a rge r in th e e a rl ie r y e a rs, th e e f f e ct of
inte re st woul d be l e ss th a n in th e e xa mp l e . T h e rise in th e wa ge ra te e nta il e d by th e f a l l . in th e ra te of
inte re st must in most ordina ry ca se s l e a d to a rise , on ba l a nce , in th e cost of ca p ita l in te rms of p roduct,
a nd ca se s in wh ich th e inte re st e f f e ct more th a n of f se ts th e Wickse l l e f f e ct se e m l ike l y to be ra th e r p e cul ia r.
2
Ha y e k, " T h e Rica rdo Ef f e ct," Economica , . Ma y , I942
3
Accumul a tion ma y be in course of p roce e ding in a n e quil ibrium p osition but, if so, it is going on
sl owl y ;- re l a tive l y to th e a mount of ca p ita l a l re a dy in e xiste nce , a nd it is going on in a ma nne r wh ich doe s
not. viol a te th e inte ma l e quil ibrium of th e sy ste m, so th a t, a t a ny mome nt, it is l e gitima te to p ostul a te
a n e xisting a mount of ca p ita l .
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 97
At a ny give n wa ge ra te , th e inte rp l a y of comp e tition be twe e n ca p ita l ists, e a ch
se e king to ma ximise h is own p rof its, is a ssume d to e nsure th a t th e te ch nique wil l be
ch ose n th a t ma ximise s th e ra te of p rof it. T h us th e te ch nique is a f unction of th e
wa ge ra te . T h e outf it of p roductive e quip me nt in e xiste nce is de te rmine d by th e
te ch nique a nd th e tota l a mount of ca p ita l . A give n outf it of e quip me nt of f e rs a give n
a mount of e mp l oy me nt. T h us we h a ve th e a mount of e mp l oy me nt a s a f unction
of
th e wa ge ra te . We ca n th e n sta te th e ne o-cl a ssica l p ostul a te : th e wa ge ra te is a ssume d
to be such th a t th e te ch nique of p roduction is such th a t th e give n qua ntity of ca p ita l
e mp l oy s th e give n l a bour f orce . It is ne ce ssa ry to p ostul a te th a t th e a mount of re a l
wa ge s (wh ich is not th e sa me th ing a s th e wa ge bil l but is gove rne d by it) in re l a tion
to th e cost of subsiste nce is a t l e a st suf f icie nt to ma inta in th e give n l a bour f orce in
be ing.
T h e re is no dif f icul ty in p rincip l e (th ough inf inite comp l ica tion) in re moving th e
trick a ssump tions a nd introducing into our a na l y sis sp e cia l ise d na tura l re source s,
va rie tie s of skil l of l a bour, a nd de ma nd e qua tions f or individua l commoditie s in te rms
of re l a tive p rice s, tota l income a nd th e distribution of income be twe e n h ouse h ol ds.
(We coul d not, h owe ve r, dige st e conomie s of sca l e , f or th a t imp l ie s th e e xiste nce of
a ctive e ntre p re ne urs, a s op p ose d to our ca p ita l ists wh ose onl y f unction is to own
ca p ita l a nd use it to e mp l oy l a bour.) We sh oul d th e n be a bl e to ma ke use of th e
sup p l y -a nd-de ma nd a na l y sis wh ich ne o-cl a ssica l e conomics h a s de ve l op e d with so
much e l a bora tion, a nd to sh ow th a t th e te ch nique wil l be ch ose n, e a ch ca p ita l ist
re ckoning wa ge s in te rms of h is own p roduct, th a t ma ximise s th e tota l of p rof its.
T h e e qua tion re l a ting th e a mount of e mp l oy me nt to th e wa ge ra te is inde p e nde nt
of th e me dium in wh ich wa ge s a re p a id to worke rs. Since it is more usua l to p a y in
mone y th a n in p e a nuts, l e t us se e h ow it works out wh e n wa ge s a re p a id in mone y ,
th a t is, some unit of ge ne ra l ise d p urch a sing p owe r.
T h e re l a tion of th e mone y p rice s of p a rticul a r commoditie s to th e ir mone y -wa ge
costs is inf l ue nce d by sup p l y a nd de ma nd f or sca rce f a ctors, by th e l e ve l of e f f e ctive
de ma nd a nd by th e p rice p ol icie s of imp e rf e ctl y comp e titive riva l p roduce rs. At a ny
give n mone y wa ge l e ve l , th e re sul ting comp l e x of p rice s de te rmine s th e wa ge in te rms
of a comp osite unit of th e p roduct wh ich is a ctua l l y be ing p roduce d. We h a ve rul e d
out f l uctua tions in e f f e ctive de ma nd but we must conside r th e inf l ue nce of comp e tition.
C omp e tition wh ich is re l e va nt to our a rgume nt is comp e tition in th e l ong-p e riod
se nse -th e re a dine ss with wh ich ca p ita l ists bre a k into a ma rke t wh e re a more th a n
a ve ra ge ra te of p rof it is rul ing a nd bid down th e p rice of th e commodity be ing sol d
th e re . Wh e n a ma rke t is domina te d by a monop ol ist, p rice in re l a tion to mone y wa ge s
is such th a t th e ra te of p rof it on h is ca p ita l is h igh e r th a n th e a ve ra ge f or th e e conomy
a s a wh ol e . C a p ita l ists f rom outside a re a nxious to e nte r th is ma rke t, a nd in doing so
th e y cut th e p rice of th e commodity , th us ra ising th e wa ge ra te e ve ry wh e re in te rms
of th is bit of th e comp osite p roduct, wh il e l owe ring it in oth e r l ine s f rom wh ich ca p ita l
is de f l e cte d. Wh e n comp e tition is f re e a nd a ctive ,
a s we a ssume it to be , th is p roce ss
of comp e ting a wa y e xce ss p rof its a nd ra ising sub-a ve ra ge p rof its is a l wa y s comp l e te l y
succe ssf ul , a nd a t a ny mome nt a unif orm ra te of p rof it is rul ing th rough out th e sy ste m.
Wh e n p rof its a re be ing h e l d a bove th e ge ne ra l l e ve l in a p a rticul a r l ine , by mono-
p ol istic re strictions, th e p roce ss is imp e de d, f or th e e xiste nce of monop ol y (in th e
l ong-p e riod se nse h e re a p p rop ria te ) me a ns p re cise l y th a t a n individua l ca p ita l ist is
a bl e to p re ve nt oth e rs f rom bre a king into h is p re se rve s a nd comp e ting a wa y h is p rof its.
In th is situa tion a tra de union ma y succe e d in ra ising th e mone y wa ge th a t its
me mbe rs re ce ive , so th a t wa ge s in te rms of p roduct in ge ne ra l -f or th a t p a rticul a r
group of worke rs a re ra ise d, wh il e th e monop ol ist (p ursuing some l ong-ra nge p ol icy )
doe s not ne ce ssa ril y counte r by ra ising th e mone y p rice of h is commodity corre s-
B
98 T HE REVIEW OF EC ONOMIC ST UDIES
p ondingl y , so th a t th e wa ge of l a bour ta ke n a s a wh ol e is ra ise d. T h e e xiste nce of a
f e w monop ol ie s h e re a nd th e re doe s not ne ce ssa ril y de p re ss re a l wa ge s f or l a bour a s
a wh ol e ; inde e d it ma y ca use th e m to be h igh e r th a n th a t wh ich corre sp onds to th e
comp e titive e quil ibrium p osition, f or th e monop ol ists ma y be e xp l oiting oth e r ca p ita l ists
a nd sh a ring th e sp oil with th e ir own worke rs. But th e ge ne ra l p re va l e nce of monop ol y
must de p re ss re a l wa ge s (unl e ss th e stre ngth of th e tra de unions a nd th e comp l a isa nce
of th e monop ol ists a re so gre a t a s to p re ve nt th e ra te of p rof it f rom rising a bove th e
comp e titive l e ve l ) f or by ke e p ing up mone y p rice s it re duce s th e wa ge ra te , in our
se nse , wh ich gove rns th e re a l wa ge ra te th a t inte re sts th e worke rs in th e ir ca p a city
a s consume rs.
Wh e n th e re a re e l e me nts of monop ol y in a n e conomy , dif f e re nt ra te s of p rof it
obta in in dif f e re nt l ine s of p roduction, with out much te nde ncy to e qua l isa tion th rough -
out th e sy ste m. T h e a rgume nt in te rms of a n e quil ibrium ra te of p rof it corre sp onding
to a give n ra tio of ca p ita l to l a bour th e n ca nnot be a p p l ie d with out a gre a t de a l of
comp l ica tion. It is f or th is re a son th a t th e a ssump tion of f re e comp e tition (in th e
l ong-p e riod se nse ) is ne ce ssa ry to it.
Give n th a t comp e tition e sta bl ish e s a unif orm ra te of p rof it th rough out th e
e conomy , a nd give n te ch nica l knowl e dge a nd th e qua ntity of ca p ita l (in te rms of
p roduct) th e re is one va l ue of th e wa ge ra te wh ich is comp a tibl e with f ul l e mp l oy me nt
of a ny give n l a bour f orce .
T h e ne o-cl a ssica l e conomists de rive d f rom th is p rop osition a doctrine wh ich
ca nnot, in f a ct, be ba se d on it. T h e y ma inta ine d th a t th e l e ve l of wa ge s de te rmine s
th e a mount of e mp l oy me nt, a nd th a t, wh e n une mp l oy me nt occurs, worke rs (unl e ss
f rustra te d by th e misguide d p ol icy of tra de unions) of f e r th e mse l ve s a t a l owe r re a l
wa ge ra te th a n th a t rul ing, a nd go on doing so til l a l l a re e mp l oy e d.
T h is doctrine wa s ch a l l e nge d by Ke y ne s, on th e ground th a t th e wa ge ba rga in
doe s not de te rmine th e re a l wa ge . Ke y ne s' a rgume nt wa s de ve l op e d to de a l with
sh ort-p e riod situa tions, but it a p p l ie s with f ul l f orce to e quil ibrium p ositions. A
ch a nge in th e p e a nut p rice , or th e mone y p rice , of a ma n h our of l a bour a l te rs th e
e quil ibrium p rice , in te rms of p e a nuts or of mone y , of e a ch commodity p rop ortiona l l y
a nd l e a ve s th e e quil ibrium ra te of p rof it a nd of wa ge s unch a nge d. In sh ort, th e p ur-
ch a sing p owe r, wh e th e r of mone y or of p e a nuts, ove r commoditie s in ge ne ra l , is
gove rne d by its p urch a sing p owe r ove r l a bour, a nd a ch a nge in th e p e a nut p rice or th e
mone y p rice of l a bour doe s not a f f e ct th e p rice of l a bour in te rms of commoditie s
in ge ne ra l .
From th e p oint of vie w of a ny one e mp l oy e r h is wa ge bil l in te rms of h is own
p roduct is by no me a ns th e sa me th ing a s th e re a l wa ge wh ich th e worke r ge ts. T h e
wa ge bil l to th e ca p ita l ist a nd th e wa ge re ce ive d by th e worke rs a re th e sa me onl y in
a strictl y one -commodity worl d, a s Rica rdo sa w wh e n h e ima gine d a sy ste m in wh ich
corn is th e onl y p roduct, a nd th e wa ge contra ct is ma de in te rms of corn.1 Wa ge
ba rga ining is conducte d in te rms of wh a t th e worke r ge ts, a nd th e wa ge wh ich e nte rs
into th e wa ge ba rga in is not th e sa me th ing a s th e wa ge wh ich de te rmine s th e qua ntity
of e mp l oy me nt. T h us th e conce p tion of th e l e ve l of e mp l oy me nt be ing de te rmine d
by th e wa ge ba rga in ca nnot be e xp re sse d (outside th e corn e conomy ) in a wa y wh ich
h a s a me a ning.2
I
Works a nd C orre sbonde nce of Da vidRica rdo, e d. Sra f f a , Vol . I, p . xxxii.
2
T h e dif f icul ty ca nnot be e va de dby p ostul a ting th a t wa ge s a re p a idin kindwith out th e use of mone y .
T o sp e cif y a " non-mone ta ry " or " non-Ke y ne sia n" e conomy it is not suf f icie nt to p ostul a te th a t th e
socie ty in que stion h a s not y e t got round to inve nting a sta nda rdise dme dium of e xch a nge . We must
p ostul a te th a t th e ve ry ide a of ge ne ra l ise dp urch a sing p owe r is unknown, so th a t e a ch se p a ra te e mp l oy e r
p a y s h is worke rs in h is own p roduct, a nd th e worke rs ba rte r th e p roducts a mongst th e mse l ve s with out
a ny tria ngul a r de a l ing.
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 99
AC C UMULAT ION
Wh a t be come s of th e ne o-cl a ssica l doctrine if we re a d' it th e oth e r wa y round
th a t th e ra te of p rof it te nds to be such a s to p e rmit a l l th e ca p ita l th a t' come s into
e xiste nce ' to be e mp l oy e d ? Sup p ose th a t th e wa ge ra te h a s be e n e sta bl ish e d a t a
l e ve l wh ich y ie l ds some conve ntiona l minimum re a l wa ge , a nd th a t, th e te ch nique
h a ving be e n ch ose n wh ich ma ximise s th e ra te of p rof it, th e qua ntity of ca p ita l in
e xiste nce doe s not e mp l oy a l l a va il a bl e l a bour, so th a t th e re is a re se rve of une mp l oy -
me nt. Accumul a tion ca n th e n' p roce e d a t a consta nt f a ctor ra tio a nd consta nt ra te
of p rof it until a l l a va il a bl e l a bour is e mp l oy e d. If p op ul a tion is incre a sing a t l e a st a s
f a st a s ca p ita l is a ccumul a ting, f ul l e mp l oy me nt is ne ve r a tta ine d, a nd th e e xp a nsion
of th e e conomy ca n continue inde f inite l y (we h a ve p ostul a te d th a t th e re 'is no sca rcity
of l a nd, incl uding a l l non-p roduce d me a ns of p roduction).
So f a r th e a rgume nt is disma l l y simp l e . Wh a t a re we sup p ose d to ima gine to
h a p p e n' wh e n th e re is f ul l e mp l oy me nt in th e l ong-p e riod se nse , th a t is, wh e n th e re is
suf f icie nt p l a nt in e xiste nce to e mp l oy a l l a va il a bl e l a bour ? One l ine of a rgume nt is to
sup p ose th a t th e ca p ita l ists wh o a re a ccumul a ting a ct in a bl indl y individua l istic
ma nne r, so th a t a scra mbl e f or l a bour se ts in ; th e mone y (or p e a nut) wa ge ra te is
bid up , a nd p rice s rise in a n inde f inite sp ira l . (It is of no use to bring th e f ina ncia l
me ch a nism into th e a rgume nt, f or if th e sup p l y of th e me dium of e xch a nge is l imite d,
th e inte re st ra te is drive n up ; but wh a t th e situa tion re quire s is a f a l l in th e ra te of
inte re st, to e ncoura ge th e use of more me ch a nise d te ch nique s.)
Or we ma y p ostul a te th a t th e ca p ita l ists, wh il e f ul l y comp e titive in se l l ing,
obse rve a conve ntion a ga inst bidding f or l a bour-e a ch conf ine s h imse l f to e mp l oy ing
a ce rta in sh a re of th e consta nt l a bour f orce . T h e n a ny one wh o wish e s to incre a se th e
a mount of ca p ita l th a t h e op e ra te s sh if ts to a more me ch a nise d te ch nique . T h ose
wh o f irst ma ke th e ch a nge ma y be sup p ose d to comp e te f or wide r ma rke ts a nd so to
re duce p rice s re l a tive l y to mone y wa ge s. T h e Rica rde sque e f f e ct is th us brough t
into p l a y , a nd th e switch to more me ch a nise d te ch nique s p roce e ds a t a suf f icie nt ra te
to a bsorb ne w ca p ita l a s it a ccrue s. Al te rna tive l y , we migh t ima gine th a t a n e xce ssive
numbe r of p l a nts of th e l e ss me ch a nise d ty p e a re a ctua l l y buil t, a nd th a t th e ir re dund-
a ncy , re l a tive l y to l a bour to ma n th e m, re duce s p rof it ma rgins, so th a t th e wa ge ra te
rise s a nd brings th e Rica rde sque e f f e ct into p l a y . (Wh ich e ve r l ine we f ol l ow th e a rgu-
me nt is ne ce ssa ril y h igh l y a rtif icia l , f or in re a l ity th e sta te of tra de is th e domina nt
inf l ue nce on inve stme nt. T h e situa tion wh ich p romote s th e me ch a nisa tion of p ro-
duction is f ul l e mp l oy me nt a nd f ul l orde r books, th a t is to sa y , a sca rcity of l a bour
re l a tive l y to e f f e ctive de ma nd, but th e e quil ibrium a ssump tions do not p e rnit us to
sa y a ny th ing a bout e f f e ctive de ma nd.)
Some h ow or oth e r, a ccumul a tion ma y be conce ive d to p ush down th e ra te of
p rof it, a nd ra ise th e f a ctor ra tio.
But th e ve ry notion of a ccumul a tion p roce e ding unde r e quil ibrium conditions a t
ch a nging f a ctor ra tios bristl e s with dif f icul tie s. T h e ra te a t wh ich th e f a ctor ra tio
rise s is not gove rne d in a ny simp l e wa y by th e p a ce a t wh ich a ccumul a tion goe s on-
it de p e nds up on th e e xte nt to wh ich th e rising wa ge ra te ca use s ca p ita l to be a bsorbe d
Se ve ra l ne o-cl a ssica l e conomists h a ve inve nte d, a s a p rop h y l a ctic a ga inst une mp l oy me nt, "commodity
-mone y " in va rious f orms, wh ich woul d p roduce a n e f f e ct a s th ough th e wa ge contra ct we re ma de in te rms
of th e comp osite commodity re p re se nting a l l outp ut. As a p ra ctica l p rop osa l , such a sch e me is ra th e r
f a ncif ul , but a s a p e da gogica l de vice e xp l a ining th e na ture of mone y , it is e xce l l e nt. Anoth e r wa y of
ima gining th e sa me re sul t is to sup p ose th a t th e worke rs a re p a id in te rms of a p e rce nta ge of th e
mone y
p roce e ds of th e f irm e mp l oy ing th e m, th a t is, th a t th e worke rs ta ke on th e risks of e ntre p re ne ursh ip . T h is
a l so sta rts a n inte re sting tra in of th ough t.
Robinson C rusoe l ive d in a comp l e te l y a mone ta ry worl d, a s De f oe ma ke s h im p oint out in h is me dita -
tions ove r a p a rce l of coins. For th is re a son h e is th e p a tron sa int of ne o-cl a ssica l e conomics..
ioo T HE REVIEW OF EC ONOMIC ST UDIES
by th e Wickse l l e f f e ct. More ove r, th e e f f e ct of a give n ch a nge in th e f a ctor ra tio de p e nds
up on th e sp e e d a t wh ich it is ma de , re l a tive l y to th e l e ngth of l if e of p l a nt. If ca p ita l
p e r ma n is rising ra p idl y some ca p ita l ists wil l stil l be op e ra ting De l ta a nd Ga mma
p l a nts wh il e oth e rs h a ve a l re a dy insta l l e d Al p h a p l a nts. (In th e se conditions th e
trick a ssump tions be come ve ry tricky inde e d.)
Eve n if we ca n f ind a wa y th rough th e se comp l ica tions, th e re re ma ins th e f ormid-
a bl e p robl e m of h ow to tre a t e xp e cta tions wh e n th e ra te of p rof it is a l te ring. An
unf ore se e n f a l l in th e ra te of p rof it rup ture s th e conditions of e quil ibrium. C a p ita l ists
wh o a re op e ra ting on borrowe d f unds ca n no l onge r e a rn th e inte re st th e y h a ve con-
tra cte d to p a y , a nd th ose op e ra ting th e ir own ca p ita l f ind th e mse l ve s in p osse ssion of
a ty p e of p l a nt th a t th e y woul d not h a ve buil t if th e y h a d known wh a t th e ra te of
p rof it wa s going to be .
On th e oth e r h a nd, if we p ostul a te th a t a ccumul a tion goe s on in th e e xp e cta tion
of a gra dua l l y f a l l ing ra te of p rof it, th e wh ol e ba sis of th e a na l y sis be come s imme nse l y
comp l ica te d. We ca n no l onge r a rgue in te rms of a singl e inte re st ra te . T h e re is a
comp l e x of ra te s f or l oa ns of dif f e re nt l e ngth s, th e ra te s f or sh orte r te rms sta nding
a bove th e ra te s f or l onge r te rms. More ove r, th e p a ce a t wh ich th e ra te of p rof it f a l l s
a s th e
f a ctor
ra tio rise s is dicta te d by te ch nica l conditions. Ove r its e a rl y re a ch e s
th e f a ctor-ra tio curve ma y be sup p ose d to be ste e p , with th e ra te of p rof it f a l l ing
sl owl y . T h e n it p a sse s ove r a h ump , with a ra p id f a l l in th e ra te of p rof it, a nd f l a tte ns
out a ga in with a l owe r but more sl owl y f a l l ing ra te of p rof it. T o be corre ct, th e e xp e cta -
tions of th e ca p ita l ists ca nnot me re l y be ba se d on p a st e xp e rie nce but re quire a h igh l y
sop h istica te d de gre e of f ore sigh t.
T h us th e a ssump tions of e quil ibrium be come e nta ngl e d in se l f -contra dictions if
th e y a re a p p l ie d to th e p robl e m of a ccumul a tion going on th rough time with a
ch a nging
f a ctor ra tio. T o discuss a ccumul a tion we must l ook th rough th e e y e s of th e ma n of
de e ds, ta king de cisions a bout th e f uture , wh il e to a ccount f or wh a t h a s be e n a ccumul a te d
we must l ook ba ck ove r th e a ccide nts of p a st h istory . T h e two p oints of vie w me e t
onl y in th e wh o's wh o of goods in e xiste nce to-da y , wh ich is ne ve r in a n e quil ibrium
re l a tionsh ip with th e situa tion th a t obta ins to-da y .
In sh ort, th e comp a rison be twe e n e quil ibrium p ositions with dif f e re nt f a ctor
ra tios ca nnot be use d to a na l y se ch a nge s in th e f a ctor ra tio ta king p l a ce th rough time ,
a nd it is imp ossibl e to discuss ch a nge s (a s op p ose d to dif f e re nce s) in ne o-cl a ssica l te rms.
T h e p roduction f unction, it se e ms, h a s a ve ry l imite d re l e va nce to a ctua l p robl e ms,
a nd a f te r a l l th e se l a bours we ca n a dd l ittl e to th e p l a titude s with wh ich we be ga n:
in country Ga mma , wh e re th e roa d buil de rs use woode n sh ove l s, if more ca p ita l h a d
be e n a ccumul a te d in th e p a st, re l a tive l y to l a bour a va il a bl e f or e mp l oy me nt, th e l e ve l
of re a l wa ge s woul d p roba bl y h a ve be e n h igh e r a nd th e te ch nique of p roduction more
me ch a nise d, a nd, give n th e a mount of ca p ita l a ccumul a te d, th e more me ch a nise d th e
te ch nique of p roduction, th e sma l l e r th e a mount of e mp l oy me nt woul d h a ve be e n.
A C HANGE IN T EC HNIC AL KNOWLEDGE
It re ma ins to inquire wh e th e r th e a na l y sis ca n be a p p l ie d to a ch a nge in our
th ird ba sic da tum, th e sta te of te ch nica l knowl e dge .
In th e ne o-cl a ssica l sy ste m, te ch nica l knowl e dge is a l te re d by inve ntions. An
inve ntion " is conce ive d not me re l y a s a n isol a te d innova tion in a me th od of p ro-
duction or th e de sign of e quip me nt. It is a discove ry wh ich h a s a wide ra nge of
a p p l ica tions a nd wh ich ra ise s th e p roductivity of l a bour ove r a wide ra nge of f a ctor
ra tios.
T h e a rgume nt is usua l l y conducte d in te rms of th e e f f e ct of inve ntions up on th e
outp ut a nd th e re l a tive e a rnings of give n qua ntitie s of ca p ita l a nd l a bour. T h us we
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL xoi
a re sup p ose d to ima gine a n e conomy ta king a sta nding jump f rom one sta tiona ry
p osition to a noth e r a nd l a nding itse l f in e quil ibrium in a ne w sta te of knowl e dge with
th e sa me sup p l ie s of f a ctors of p roduction a s be f ore . T h is ma ke s th e contra dictions
invol ve d in th e ne o-cl a ssica l conce p tion of e quil ibrium a nd th e a mbiguitie s invol ve d
in th e conce p tion of a consta nt qua ntity of ca p ita l more f ormida bl e th a n e ve r.
Howe ve r, it is p ossibl e once a ga in to distil some th ing f rom th e ingre die nts of th e
a rgume nt. T e ch nica l p rogre ss ma y be incorp ora te d into th e conditions of e quil ibrium
if we p ostul a te th a t inve ntions a re e xp e cte d to be ma de a t a ce rta in ra te a nd th a t, in
f a ct, th e y do succe e d e a ch oth e r in a smooth a nd re gul a r ma nne r. Al l ca p ita l goods
a re , th e re f ore , p rovide d with obsol e sce nce f unds, wh ich a l l ow e quip me nts to be
tra nsmogrif ie d to suit ne w te ch nique s with out a ny l oss of ca p ita l in te rms of p roduct.
An inve ntion th e n doe s not give a sh ock to th e sy ste m rup turing th e conditions of
e quil ibrium, a nd we ca n continue to rul e out p robl e ms of e f f e ctive de ma nd by a ssuming
th a t sa ving is ge a re d to inve sting so th a t if a ccumul a tion is ta king p l a ce it goe s on a t
a ste a dy ra te with out a ny p e rturba tions.
We a re a l so obl ige d to p ut a h e a vy we igh t on th e trick a ssump tions, f or it is
imp ossibl e to comp a re th e e f f icie ncy of dif f e re nt me th ods of p roduction unl e ss th e y
a re de signe d f or simil a r outp uts.
Subje ct to th e se p rovisos, we ca n (with due re se rva tions) ma ke use of th e f ore -
going a na l y sis to comp a re e quil ibrium p ositions of th e e conomy a t two p oints of
time . In th e f irst p osition, sa y , Be ta te ch nique is in use .
FIG.U
OUT PUT
, . . , ' I
N 0 ~~ ~~~~~~F
REAL C APIT AL
In th e
dia gra m
' is th e
p oint
of
e quil ibrium
on th e f a ctor-ra tio curve in th e f irst
p osition ;
th e f a ctor ra tio is OF ;
a nd th e
e l a sticity
of th e
p roductivity
curve th rough
f i is e
(th e p roductivity
curve is dra wn
up using
th e Be ta ra te of
p rof it
a s th e notiona l
I02 T HE REVIEW OF EC ONOMIC ST UDIES
inte re st ra te : its e l a sticity is e qua l to th e sh a re of p rof it in outp ut wh e n e quil ibrium
obta ins a t /3).
Now dra w th e p roductivity curve f or th e ne w sta te of knowl e dge using th e ra te
of p rof it wh ich obta ins a t /3 a s th e notiona l inte re st ra te . Le t ,B+ be th e p oint on th is
curve corre sp onding to th e f a ctor ra tio OF.
If th e e l a sticity of th e curve a t /3+ we re e qua l to
e ,
th e wa ge ra te a t f a ctor ra tio
OF woul d h a ve be e n ra ise d by th e imp rove me nt in te ch nique in th e sa me p rop ortion
a s outp ut. C a p ita l p e r unit of outp ut, a nd th e ra te of p rof it on ca p ita l woul d, th e re f ore ,
be th e sa me a s in th e f irst p osition. If th e e l a sticity a t /3+ we re l e ss th a n e , th e wa ge
ra te woul d be ra ise d more th a n in p rop ortion to outp ut, a nd th e sh a re of p rof it in
outp ut a nd th e ra te of p rof it on ca p ita l woul d be re duce d (re a djusting f or a l owe r
notiona l inte re st ra te re inf orce s th e se re l a tions). T h e conve rse woul d h ol d if th e
e l a sticity a t /+ we re gre a te r th a n e .
A l owe r e l a sticity of th e p roductivity curve imp l ie s th a t a s we move up . th e ne w
h ie ra rch y of te ch nique s, Ga mma + to Be ta + to Al p h a +, outp ut p e r ma n rise s
p rop ortiona te l y l e ss th a n wa s th e ca se with th e ol d h ie ra rch y . T h e re is, so to sa y , l e ss
scop e in th e ne w situa tion f or th e Rica rde sque e f f e ct to work. T h us inve ntions wh ich
a l te r th e sh a p e of th e p roductivity curve in th is wa y (ove r th e re l e va nt ra nge of f a ctor
ra tios) ma y be ca l l e d unf a voura bl e to ca p ita l , th ose wh ich l e a ve th e e l a sticity a t a
give n f a ctor ra tio unch a nge d, ne utra l , a nd th ose wh ich ra ise it, f a voura bl e to ca p ita l .
T h e na ture of th e te ch nica l ch a nge doe s not by itse l f de te rmine a ne w p osition
of e quil ibrium. T h a t de p e nds a l so up on h ow much a ccumul a tion took p l a ce wh il e th e
te ch nica l ch a nge wa s be ing ma de . As we h a ve se e n, f or th e f a ctor ra tio to re ma in
unch a nge d, wh e n th e inve ntions h a ve be e n ne utra l , ca p ita l must h a ve incre a se d in th e
sa me p rop ortion a s outp ut. With a ny sma l l e r a mount of a ccumul a tion th e f a ctor
ra tio is re duce d, th e sy ste m must be sup p ose d to h a ve move d in th e dire ction of , sa y ,
y +
or a
+,
a nd th e sh a re of
p rof it
in
outp ut
a nd th e ra te on
ca p ita l
a re
h igh e r
th a n
th e y we re a t /3.
T h us th e e f f e ct of inve ntions, unl e ss th e y a re h igh l y unf a voura bl e to ca p ita l in a
te ch nica l se nse , is to ra ise th e ra te of p rof it obta ina bl e by a give n a mount of ca p ita l ,
a nd to incre a se its re l a tive sh a re in outp ut.
T h e a bove a na l y sis th rows some l igh t on th e controve rsy be twe e n th e e conomists
a nd th e Luddite s, a nd sup p orts Rica rdo's a rgume nt On Ma ch ine ry .1 Wh e n th e na ture
of inve ntions is suf f icie ntl y f a voura bl e to ca p ita l , th e wa ge ra te a t th e f a ctor ra tio OF
is re duce d by th e m. But if th e wa ge ra te rul ing a t / p rovide d a re a l wa ge no gre a te r
th a n th e subsiste nce minimum, it is imp ossibl e f or th e wa ge ra te in a ne w p osition
of e quil ibrium to be a ny l owe r. T h e re is a p ossibl e p osition of e quil ibrium a t a h igh e r
f a ctor ra tio, sa y a t a +, wh e re th e wa ge ra te is th e sa me a s th a t wh ich p re va il e d a t /.
But to p rovide a h igh e r f a ctor ra tio f or a consta nt l a bour f orce a t a consta nt wa ge
ra te re quire s a n incre a se in th e qua ntity of ca p ita l . If th e qua ntity of ca p ita l h a s not
incre a se d suf f icie ntl y , th e h igh e r f a ctor ra tio ca n be a tta ine d onl y by re ducing e m-
p l oy me nt. T h e re is th e n a
"
substitution of ca p ita l f or l a bour
"
in a l ite ra l a nd bruta l
se nse .
T o re turn to our roa d buil de rs-if inve ntions ma de it p rof ita bl e to introduce
bul l doze rs in country Ga mma th e worke rs th e re woul d be much worse of f th a n th e y
we re with woode n sh ove l s, unl e ss a t th e sa me time th e re we re a suf f icie nt a ccumul a tion
of ca p ita l to p rovide th e l a bour disp l a ce d f rom roa d buil ding with e mp l oy me nt in
oth e r industrie s.
T h is sch e me of a na l y sis p rovide s th e ba sis f or th e mode l of a ca p ita l ist sy ste m
1 Princip l e s, T h irdEdition, C h a p te rXXXI.
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 103
e njoy ing continuous e xp a nsion. Wh e re te ch nica l p rogre ss is ne utra l a nd a ccumul a tion
goe s on a t just such a ra te a s to ke e p th e ra tio of ca p ita l to outp ut consta nt, th e sh a re
of ca p ita l a nd l a bour in outp ut a nd th e ra te of p rof it on ca p ita l re ma in consta nt a nd
th e mode l is f re e f rom " inte rna l contra dictions."'
In oth e r ca se s th e comp l ica tions a rising f rom ch a nge s in th e distribution of income
be twe e n cl a sse s a nd, ch a nging e xp e cta tions of p rof its a re too gre a t to be dige ste d by
th e a ssump tions of e quil ibrium, a nd it is idl e to p ursue th e a rgume nt a ny f urth e r
with out ta king a ccount of th e p robl e m of e f f e ctive de ma nd.
C ONC LUSION
T h e te nor of our a rgume nt h a s be e n ma inl y ne ga tive a nd th e l e ve l of a bstra ction
ma inta ine d in th e a na l y sis is ve ry h igh . Ne ve rth e l e ss, we ca n dra w some ge ne ra l
concl usions f rom it. T h e concl usions sound obvious e nough , but p e rh a p s th a t is a l l
to th e good, a s it sh ows th a t th e p rop ositions dra wn f rom th e a bstra ct a rgume nt a re
not in conf l ict with common se nse .
T h e ra te of p rof it on ca p ita l wil l te nd to be h igh e r, a nd re a l wa ge s l owe r:
(i) th e more p l e ntif ul a re th e te ch nica l op p ortunitie s f or me ch a nising p ro-
duction;
(2) th e sl owe r is th e ra te of ca p ita l a ccumul a tion in re l a tion to th e growth of
p op ul a tion;
(3)
th e we a ke r is th e f orce of comp e tition (a nd th e we a ke r is th e ba rga ining
p owe r of th e worke rs, wh e n comp e tition is we a k).
Give n th e de gre e of comp e tition a nd th e ra te of growth of p op ul a tion, th e course of
th e ra te of p rof it ove r th e l ong run (a bstra cting f rom sh ort-p e riod f l uctua tions) de p e nds
on th e inte ra ction be twe e n te ch nica l p rogre ss a nd th e ra te of a ccumul a tion. T e ch nica l
discove rie s (unl e ss e xtre me l y unf a voura bl e to ca p ita l ) a re continuousl y te nding to
ra ise th e ra te of p rof it a nd a ccumul a tion is te nding to de p re ss it. Prosp e rous ca p ita l ist
e conomie s a re th ose wh e re th e ra te of p rof it is f a l l ing in sp ite of ra p id te ch nica l p rogre ss,
a nd mise ra bl e one s th ose wh e re th e ra te of p rof it is h igh in sp ite of te ch nica l sta gna tion.
C a mbridge . JOAN ROBINSON.
APPENDIX
T HE FAC T OR-RAT IO C URVE AND T HE C APIT AL-RAT IO C URVE
T h e , re l a tions be twe e n th e f a ctor ra tio a nd th e ra tio of ca p ita l (in te rms of p roduct)
to l a bour e mp l oy e d discusse d a bove (p . 93) ca n be se t out dia gra ma tica l l y
a s f ol l ows:
T h e up p e r h a l f of Fig. III (ove rl e a f ) re p e a ts Fig. I. T h e sl op e of th e stra igh t l ine ,
y 2
P2
is th e ra tio of a n incre me nt of outp ut to th e incre me nt of re a l
ca p ita l
with wh ich it is
a ssocia te d, a nd a t a consta nt wa ge ra te a n incre me nt of outp ut is a n incre me nt of
p rof it;
th us th is sl op e is th e ra tio of th e incre me nt of p rof it to a n incre me nt of re a l ca p ita l .
T h e re f ore , by p roducing 2 Y2 to cut th e y a xis in
wy p
we f ind th e wa ge ra te ,
OWy p ,
a t
wh ich Ga mma a nd Be ta te ch nique s a re indif f e re nt. Wh e n outp ut is
OC ,
Wy p C
is
p rof it p e r ma n e rmp l oy e d, a nd wh e n outp ut is OB, W7p B is p rof it p e r ma n. Simil a rl y ,
OWp a
(wh e n
a l ,f 1
cuts th e y a xis in
Wp a )
is th e wa ge ra te a t wh ich Be ta a nd Al p h a
te ch nique s a re e qua l l y p rof ita bl e .
1
At th is p oint th e a rgume ntjoins on to th a t se t out in T h e Ra te of Inte re sta ndOth e i Essa y s, p . 9o.
I04 T HE REVIEW OF EC ONOMIC ST UDIES
At a ny f a ctor ra tio, th e a mount of ca p ita l p e r ma n (th a t is, ca p ita l in te rms of
p roduct) is e qua l to re a l ca p ita l p e r ma n mul tip l ie d by th e wa ge ra te . T h us, a t
P.,
ca p ita l p e r ma n is
Ob2. OWy f p
a nd th e ra te of p rof it on ca p ita l rul ing ove r th e ra nge
r2P2
is
e qua l
to
Wy B/Ob2
.
OW.0-
Produce
t2;
to cut th e x a xis
in
N. T h e n
OWy a l ON
Wy p B/Ob2.
T h e re f ore , th e ra te of p rof it on ca p ita l is e qua l to i /ON. Simil a rl y th e ra te of
p rof it ove r th e ra nge
#l a ,
is
i
IOM wh e n a L8l cuts th e x a xis in M.
OUT PUT
I I
FIG E W I I
/ ~~~~~I I
M N O <21 f f i ,0
2;
REAL C APIT AL
A "'I
OUT PUT
B
C
I2 I
WWO
: I
~~~WAGE RAT E
Wy .$
I
I
l
I
C APIT AL
We ca n now dra w a curve re l a ting outp ut to th e ra tio of ca p ita l to l a bour e m-
p l oy e d, th a t is, to ca p ita l p e r ma n in te rms of p roduct. In th e l owe r h a l f of Fig. III th e
y a xis is ide ntica l with th a t of th e up p e r h a l f ; th e x a xis me a sure s ca p ita l p e r ma n,
inste a d of re a l ca p ita l p e r ma n. Ph y sica l ca p ita l , th a t is th e wh o's wh o of ca p ita l
goods corre sp onding to e a ch ra te of outp ut, is una f f e cte d by th e ma nne r in wh ich th e
ite ms comp osing it a re va l ue d, a nd p oints give n th e sa me na me s
(PI,
a 2, e tc.) corre sp ond
to ide ntica l te ch nica l situa tions. T h e dista nce OS2 on th e l owe r x a xis is e qua l to th e a re a
Ob2OWYP
in th e up p e r h a l f of th e dia gra m. T o f a cil ita te comp a rison, we ta ke th e
dista nce
OW.,P
a s th e unit f or x on th e l owe r a xis, a nd ma ke th e dista nce
Ob2
e qua l
to Os2. T h e n th e two stra igh t l ine s
y 2P2
a re ide ntica l .
T HE PRODUC T ION FUNC T ION AND T HE T HEORY OF C APIT AL 105
At
#2
a l l me n a re e mp l oy e d with Be ta te ch nique , a nd a rise in th e f a ctor ra tio a nd
th e ca p ita l ra tio re quire s a rise in th e wa ge ra te to
OWp ..
C a p ita l p e r ma n th e n incre a se s
to
Os,,
on th e l owe r x a xis, wh il e re a l ca p ita l p e r ma n f a l l s to Ob1 on th e up p e r x a xis.
(In th is ca se th e rise in th e wa ge ra te more th a n of f se ts th e f a l l in re a l ca p ita l due to
a l owe r ra te of p rof it. T h e Wickse l l e f f e ct outwe igh s th e inte re st e f f e ct.
T h e sl op e of
y 2f
in th e l owe r h a l f of th e dia gra m
(Wp y B/Os2)
is th e ra te of p rof it
on ca p ita l wh ich obta ins wh e n Ga mma a nd Be ta te ch nique s a re indif f e re nt, a nd th e
sl op e of
Bl a ,
is th e ra te of p rof it wh e n Be ta a nd Al p h a te ch nique s a re indif f e re nt. T h e
gre a te r l e ngth of s1r1 on th e l owe r x a xis comp a re d to
bl a 1
a nd th e sma l l e r sl op e of th e
corre sp onding stra igh t l ine
Al a ,
re f l e cts th e e xce ss of th e
f l a
wa ge ra te ove r th e
y f i
wa ge ra te .
FIG ]Y OUT PUT
W'
1 - /
4 1~~~~~~~~~~~~~~~~~~~~~~~~4
Jk
J
APIAL0 ~REAL ~ C APIT AL
~~~~~~~C APIT AL
Smooth ing out discontinuitie s in th e p roductivity curve s, we ma y dra w a p a ir of
dia gra ms
f or th e f a ctor-ra tio curve a nd th e ca p ita l ra tio curve a s in Fig. IV. We ta ke
re a l ca p ita l a s th e x a xis in th e righ t h a nd p a rt of th e dia gra m a nd ca p ita l in th e l e f t
h a nd.
C orre sp onding to e a ch of th e f a mil y of p roductivity curve s in th e righ t h a nd is
wh a t we ma y ca l l a p se udo-p roductivity curve on th e l e f t h a nd, sh owing wh a t
ca p ita l p e r ma n woul d be if th e wa ge ra te we re th a t wh ich is comp a tibl e with th e ra te of
inte re st use d in- dra wing th e corre sp onding p roductivity curve . Ea ch p se udo p ro-
ductivity curve h a s a me a ning onl y in th e ne igh bourh ood of th e p oint of e quil ibrium
corre sp onding to th e wa ge ra te on th e ba sis of wh ich it is dra wn.
T h e f a ctor-ra tio curve cuts th e f a mil y of p roductivity curve s f rom be l ow a s it
rise s. T h e ca p ita l -ra tio curve cuts th e p se udo p roductivity curve s f rom a bove .
T h e p oint
f i
on e a ch curve corre sp onds to th e outp ut OB. Dra w a ta nge nt to th e
p roductivity curve th rough
P.
By th e sa me re a soning a s a bove , its inte rce p t on th e
y a xis,
OWp ,
is th e wa ge ra te a t wh ich th e corre sp onding te ch nique wil l be in use . As
be f ore , we ta ke
OWp
a s th e unit f or th e ca p ita l a xis, so th a t th e ta nge nt to th e p se udo-
xo6 T HE REVIEW OF EC ONOMIC ST UDIES
p roductivity curve th rough f on th e ca p ita l -ra tio curve is dra wn a s ide ntica l with
th a t to th e p roductivity curve th rough f on th e f a ctor-ra tio curve . T h e e l a sticity of
th e ta nge nt,
Wp B/OB,
is th e ra tio of p rof it to outp ut, or re l a tive sh a re of ca p ita l in
p roduct.
Simil a rl y , dra w ta nge nts a t a . T h e e l a sticity of th e p a ir of ta nge nts is th e sa me ,
th e gre a te r dista nce to th e l e f t of th e l e f t h a nd p osition of a comp e nsa ting f or th e
sma l l e r sl op e of th e ta nge nt. T h e sl op e of th e ta nge nt on th e l e f t (Wa A/Aa ) is th e ra te
of p rof it on ca p ita l .
It is conve nie nt f or some p urp ose s to conce ive th e p roductivity curve s a s con4
tinuous, e a ch te ch nique re quiring a n inde f inite l y sma l l incre a se in ca p ita l p e r ma n
comp a re d to th e l a st. But it is h a rd to p icture wh a t th is woul d me a n in re a l ity (e ve n
in th e f a mous wine ce l l a r). More ove r, th e e sse ntia l na ture of th e me ch a nism of th e
re l a tionsh ip be twe e n th e ra te of wa ge s a nd th e ch oice of te ch nique ca n be unde rstood
onl y in te rms of discontinuous curve s ; we must, th e re f ore , th ink of a p oint, such a s
,B or a in Fig. IV, a s be ing a sma l l stra igh t l ine se gme nt of a curve , ove r wh ich two
te ch nique s a re indif f e re nt, ra th e r th a n a s re p re se nting th e p roduct of a singl e te ch nique .
T h e ge ome try re ve a l s a curious p ossibil ity .' It ma y h a p p e n th a t, ove r a ce rta in
ra nge , a re duction in th e ra te of inte re st p roduce s a l a rge r re duction in th e ca p ita l cost of
th e e quip me nt f or a l owe r th a n f or a h igh e r te ch nique , so th a t succe ssive wa ge ta nge nts
be come ste e p e r a s th e ra te of p rof it f a l l s. T h e y ma y th e n f ind conta ct with p roductivity
curve s a t succe ssive l y l owe r p oints, so th a t a l owe r ra te of p rof it (a nd a h igh e r wa ge
ra te ) re sul ts f rom th e use of a l e ss me ch a nise d te ch nique . T h is migh t occur if th e
p l a nt re quire d f or l e ss me ch a nise d te ch nique s h a d a much l onge r ge sta tion p e riod or
working l if e , so a s to be much more se nsitive to th e inte re st ra te th a n th a t f or more
me ch a nise d te ch nique s. T h is " p e rve rse " be h a viour of th e f a ctor-ra tio curve , wh e re
it occurs a t a l l , ca n be onl y ove r a ce rta in ra nge . At ve ry l ow va l ue s of th e ra te of
inte re st th e dif f e re ntia l e f f e ct (a s be twe e n te ch nique s) of ch a nge s in th e inte re st ra te
must be sma l l , so th a t th e re must be a n up p e r ra nge , on th e wa y to Bl iss, ove r wh ich
th e f a ctor ra tio curve rise s to th e righ t a s th e ra te of inte re st f a l l s ;
a nd th e de gre e of
me ch a nisa tion must h a ve re a ch e d a ce rta in l e ve l be f ore th e re is a ny scop e f or it to f a l l ,
so th a t th e re must be a l owe r ra nge ove r wh ich th e f a ctor ra tio curve rise s. In th e
ca se wh e re th e curve a t f irst rise s in a " norma l " ma nne r, th e n f a l l s to th e l e f t
" p e rve rse l y ," th e n rise s a ga in, th e re is e vide ntl y a ce rta in ra nge of te ch nique s wh ich
p rovide p ossibl e p ositions of e quil ibrium a t th re e dif f e re nt wa ge ra te s. A good de a l of
e xp l ora tion of th e p ossibl e ma gnitude a nd be h a viour of th e inte re st e f f e ct is ne e de d
be f ore we ca n sa y wh e th e r th e a bove is a me re th e ore tica l rigma rol e , or wh e th e r th e re
is l ike l y to be a ny th ing in re a l ity corre sp onding to it.
I
T h is wa s p ointe dout to me by Miss Ruth C oh e n.