The Investment Demand Schedule and the Keynesian Equilibrium: A Comment

Abstract

In a past issue of this Bulletin, J. F. Brothwell has emphasized the distinction between the marginal efficiency of capital and the marginal efficiency of investment; two concepts, he argues, '(that) have often been confused in the Literature'.l In apportioning the blame for this state of affairs, Brothwell follows A. P. Lerner (The Economics o f Control)2 and indicts Keynes as the source of the initial conf~sion.~ Whilst such a criticism may be perfectly valid in the case of many so-called Keynesian models, it is contended here that Keynes was himself guiltless of such a charge, that he was perfectly aware of the stock/flow distinction and also that he recognized the potential instability of the model should the capital goods industries be operating at a level of production well below their capacity; a characteristic of the model, which Brothwell notes as regards his own analysis 'is a far cry from the stable model usually presented '.4 Keynes defines the marginal efficiency of capital as being equal to 'that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price'.5 For any given capital goods industry, as investment increases and additions are made to the capital stock, the rate of discount necessary to equate prospective yields to the current supply price of capital assets will decline.The required rate of discount will decline, firstly, because, as a consequence of the greater productive capacity of the enlarged capital stock, a smaller discount rate will have to be applied to that diminished prospective yield in order to equate it to a constant or rising supply-price of capital assets. Secondly, the rate of discount applied to a constant or diminishing prospective yield will have to be discounted at a lesser rate in order to equate that prospective yield to a rising supply-price. In general, the pressure on the facilities of production of any particular type of capital will, as output increascs, cause the supply-price to rise.Thus, for each capital goods industry, Keynes describes how a schedule may be built up 'showing by how much investment in (that industry) will have to increase within the period, in ordcr that its marginal efficiency fall to any given figure'.6 If this procedure is repeated for all the capital goods industries, it is possible to determine the aggregate increase in investment required within the period in order that the marginal efficiency fall to any given rate.Thus, one point on the schedule, relating aggregate investment per period to the corresponding marginal efficiency of capital in general, is determined, and, J. ,F. Brothwell, The Investment Demand Schedule and the Keynesian Equilibrium, A. P. Lerner, The Economics of Control, Macmillan, 1964, pp. 332-8. 'The confusion in much of Capital and Investment theory between these two fundamentally different, though related, concepts may be partly ascribed to Keynes himself, who called the MEI-schedule the MEC-sc...