The Investment Function

Abstract

The theory discussed in Chapter 4, on the production function, can also form the basis of a study of the demand for labour and the demand for capital, whether the equipment, structures, inventory, or cash of business firms, as well as, by stretching a point, the demand for consumer durables, including especially that for housing. We may, for businesses at least, assume a profit-maximizing neoclassical aggregate firm and investigate its optimal capital and labour decisions; we may also adopt a cost-minimization framework, and this is often recommended on account of its ease of manipulation (and the existence of certain types of data). Note that we get from the profit/cost framework to the investment decision of the aggregate firm by introducing some explicit dynamics involving both (a) a formal stock flow dimension and (b) lags in decision-making and in implementing capital spending (once decisions to invest have been made). These matters will be taken up in Section 5.3, after we have considered some of the work prior to the synthesis now in common use; this latter may be referred to as a “neoclassical investment function” with a “flexible accelerator” mechanism.