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A Non-Walrasian Microeconomic Foundation of the “Profit Principle” of Investment

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Essays in Economic Dynamics

Abstract

In this chapter, microeconomic foundation of the “profit principle” of investment is discussed from a non-Walrasian/Keynesian perspective. A non-Walrasian “quantity constraint” is introduced in the intertemporal profit maximization problem to consider non-Walrasian/Keynesian excess supply situations. Consequently, we find that it is possible to provide microeconomic foundation for the profit principle in the case of static expectations but it may not in the case of more general types of expectations. We also clarify that Tobin’s q can also be defined in non-Walrasian/Keynesian excess supply situations.

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Notes

  1. 1.

    The profit principle of investment is often confused with the “acceleration principle” of investment, which was used by Harrod (1936), Samuelson (1939), Hicks (1950) and Goodwin (1951) in their business cycle models, but as Kaldor (1940, p. 79, f. n. 3) pointed out, they are different from each other because the latter asserts that investment demand is determined by the rate of changes in income, not by the level of income. In reviewing Hicks (1950), Kaldor (1951, p. 837) also argued that the profit principle is more akin to Keynes’ (1936) marginal efficiency theory of investment than the acceleration principle is. Moreover, the acceleration principle is not a theoretical consequence but an empirical law. For these reasons, in this paper, we focus on the microeconomic foundation of the profit principle.

  2. 2.

    The difference between the concepts of capital and of investment was pointed out by, for example, Lerner (1944) and Haavelmo (1960).

  3. 3.

    We mean by the utilization principle of investment that investment demand is determined by the rate of utilization. Along with the profit principle, use has intensively been made of it in the post-Keynesian analysis (e.g., Steindl 1952, 1979; Rowthorn 1981; Dutt 1984, 2006; Amadeo 1986; Skott 1989; Marglin and Bhaduri 1990; Lavoie 1992; Sasaki 2010; Murakami 2016).

  4. 4.

    The existence of “quantity constraint” may seem incompatible with the assumption of a price-taking firm. Certainly, as Arrow (1959, pp. 45–47) clarified, if a supplier of a commodity cannot sell all he can produce, i.e., if he faces a quantity constraint, he may act as if he were a monopolist, who takes account of the (perceived) inverse demand function of his product in his decision-making. As Negishi (1979) maintained, however, the assumption of a price-taker can be defended even in non-Walrasian excess supply situations, by introducing the assumption of a kinked demand curve (á la Sweezy). Indeed, Negishi (1979) stated as follows:

    More important for oligopolistic price rigidity is, therefore, the fact that, as Sweezy stated, any shift in demand will clearly first make itself felt in a change in the quantity sold at the current price. In other words, a shift in demand changes the position of the starting point P at which the kink occurs to the right or left without affecting the price. If the marginal cost is not increasing rapidly, the equilibrium price remains unchanged while shifts in demand are absorbed by changes in the level of output. (pp. 80–81)

    Although Arrow did not mention it explicitly, such an imperfectly demand curve must be considered to have a kink at the currently realized point or the starting point in the sense of Sweezy. Firstly, perceived demand curves generally have kinks in a non-Walrasian monetary economy where information is not perfect. (p. 87)

    When demand falls short of supply, the model of competitive suppliers, is therefore, very much like the Sweezy model of oligopoly, at least in some formal aspects. (p. 88)

    If the firm has a perceived demand with kinks due to, for instance, lack of information, as Negishi explained, it is rational for the firm to respond to changes in the demand conditions by adjusting the quantity of its output (which corresponds to the output-capital ratio in our case) rather than by varying the price. In this respect, the assumption of a price-taker is compatible with the existence of quantity constraint. Thus, in what follows, it is implicitly assumed that the firm faces a kinked demand curve in the Sweezy–Negishi sense.

  5. 5.

    Grossman (1972) derived the optimum level of capital stock from the profit maximization problem and then formalized investment as a discrepancy between the optimum and current levels of capital stock, while we directly derive the optimum investment from the profit maximization problem by introducing the concept of adjustment costs. In his approach, the optimum level of capital stock can be rationalized but investment itself cannot.

  6. 6.

    This constraint was adopted by Grossman (1972).

  7. 7.

    As we will see in (14), the ratio x is related to the (expected) rate of profit \(\rho \).

  8. 8.

    It can be verified that, under (4) and (5) deduced from Assumption 1, the inverse functions \(f^{-1}, f'^{-1}: \mathbb {R}_{++} \rightarrow \mathbb {R}_{++}\), exist.

  9. 9.

    The same condition as (11) can be found in Barro and Grossman (1971, p. 85), which characterizes non-Walrasian excess supply situations. However, their analysis was static in nature.

  10. 10.

    The expected rate of gross profit \(\rho \) is, in principle, identical to Keynes’ (1936, chap. 11) marginal efficiency of capital. However, as long as condition (11) holds, it is generally not equal to the marginal productivity of capital.

  11. 11.

    Lerner (1944) argued that the term “marginal efficiency of capital” used in Keynes’ (1936) General Theory should be renamed “marginal efficiency of investment” because the concepts of optimal capital stock and optimal investment are different from each other.

  12. 12.

    The difference between the concepts of capital and of investment was pointed out by, for example, Lerner (1944) and Haavelmo (1960).

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Acknowledgments

The author would like to thank a referee for his/her comments on the earlier version of this paper. Needless to say, the author is solely responsible for possible remaining errors in this paper. This work was financially supported by the Japan Society for the Promotion of Science (Grant-in-Aid for JSPS Fellows, Grant Number 14J03350).

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Authors and Affiliations

  1. Graduate School of Economics, University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan

    Hiroki Murakami

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  1. Hiroki Murakami
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Editors and Affiliations

  1. Department of Economic, Chuo University Department of Economic, Hachioji, Tokyo, Japan

    Akio Matsumoto

  2. University of Pecs , Pecs, Pecs, Hungary

    Ferenc Szidarovszky

  3. Faculty of Economics, Chuo University Faculty of Economics, Hachioji, Tokyo, Japan

    Toichiro Asada

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Murakami, H. (2016). A Non-Walrasian Microeconomic Foundation of the “Profit Principle” of Investment. In: Matsumoto, A., Szidarovszky, F., Asada, T. (eds) Essays in Economic Dynamics. Springer, Singapore. https://doi.org/10.1007/978-981-10-1521-2_8

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  • DOI: https://doi.org/10.1007/978-981-10-1521-2_8

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