As outlined in the previous chapter, accelerator theory paved the way for the development of models in which quantity factors determine investment decisions. In this chapter, Jorgenson’s (1963) neo-classical model of investment, which as well as allowing a role for quantity factors also introduces the relative cost of capital. As will be seen, the basic building blocks of Jorgenson’s model are similar to the building blocks of accelerator theory. Both theories describe a process of capital stock adjustment to a desired or optimal level. However, a crucial difference between the two models emerges in the role that each credits to relative factor costs. In accelerator theory, the capital stock does not adjust in response to changes in factor costs because production processes are like ‘clay’, with fixed capital—output ratios. In these models, capital and labour are complementary factors, used in fixed proportions with a fixed capital—labour ratio. In contrast, in Jorgenson’s theory, the capital stock does adjust to changes in relative factor costs and investment will be affected by these changes in costs. The relative cost of capital is captured in Jorgenson’s model by the user cost of capital. Optimizing investors will balance this user cost of capital with the marginal productivity of capital when they decide about their optimal capital stock.
KeywordsCapital Stock Marginal Productivity Real Interest Rate Capital Good User Cost
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