This theory is called neoclassical theory of investment behaviour because it is based on the neoclassical theory of optimal capital accumulation which is determined by relative prices of factors of production. The classical view, the predominant economic philosophy … The theory states that economic growth is the result of three factors—labor, capital, and technology. This, in its turn, depends on the cost of building, delivering and installing new capital. We should point out now that our emphasis … The neoclassical … Thus, according to the flexible accelerator model, to make partial adjustment in each period the firms decide to undertake investment is each period, which is a fraction, say λ, of the total gap between the existing capital stock and the desired capital stock in each period. Privacy Policy3. When the level of output or national income is expected to increase the whole curve of marginal product of capital (MPK) will shift to the right as shown in Fig. continue making investment) until the marginal product of capital (MPK) is equal to the rental price of capital. The user cost of capital will be explained in detail later, but it essentially stands for the rental for capital a firm owns or gets it on rent basis and measures the opportunity cost of the funds spent on production or purchase of a capital equipment. So, ultimately, as the economy’s capital stock adjusts, the MPK approaches the real cost of capital and the steady-state level of capital is expressed as: Since in such a situation total profit from capital is maximum (constant) and marginal profit is zero, no addition is made to society’s stock of capital, i.e.. because MPK – (PK/P) (r + d) = 0. The focus of attention in Jorgenson’s theory is on the typical production firm. Neoclassical investment theory, on the other hand, fails even to acknowledge the existence of the problem. Disclaimer Copyright, Share Your Knowledge Net investment refers to the absolute change in the capital stock of a firm (I = ΔK = Kt – Kt-1,). user cost) of capital (r/P). Because it takes time to build and install new machines, construct new factories, warehouses etc., the firms cannot immediately achieve the desired level of capital stock. It may be recalled that fixed business investment refers to the purchase of machines, construction of new factories, warehouses, office buildings etc. For example, a favourable technological change which raises the MPK increases the amount of capital goods that lease-renting firms desire to buy at the same real rate of interest. Share Your Word File Marginal product of capital (MPK) measures the addition to the production by using an additional unit of capital, labour and technology remaining constant. The equation (2) shows that desired capital stock depends on the level of output (Yt). Our mission is to provide an online platform to help students to discuss anything and everything about Economics. The flexible accelerator model can also be modified to allow for changes in the speed with which investment is carried out (that is, the change in fraction λ is in fact the choice variable for the firm which is affected by such factors as the availability of credit, rate of interest, corporate tax rate, investment tax credit etc. Therefore, the firms make some adjustment in the capital stock in each period to finally attain the desired capital stock over time. In a series of papers1Jorgenson has advanced what he calls ‘the neoclassical theory of investment’. Therefore, as long as the value of marginal product of capital (which are in fact marginal receipts or benefits it gets from the use of capital in production) exceeds the rental or user cost capital, it will be profitable for the firm to add to its stock of capital. Marginal product of capital can be obtained by differentiating the production function with respect to labour. It also considers the growth of the resources in the long term. The speed of adjustment toward the steady state depends on the speed with which firms adjust their capital stock. 18.3(b) to shift to the right to I’. An important such hypothesis is called flexible accelerator model. The neoclassical theory of management took the human factor into account. There is no point in buying this machine at a high cost. The interest cost is iPK where i is the nominal interest rate and PK is the purchase price of a unit of capital. 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