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ECOS3001 - ALTERNATIVE CLOSURES OF THE PRICE SYSTEM A key...

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A key question for the modern classical approach concerns the choice of the exogenous distributive variable: are there problems with choosing the real wage ? What are the forces governing the real wage, assuming it is not tied to a subsistence level? Bargaining in the labour market? Are there problems with this view? Are there grounds for taking the rate of profit as exogenous? View shared by different schools of thought that in the long-run the rate of return to capital and the rate of interest would move together ALTERNATIVE CLOSURES OF THE PRICE SYSTEM
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However there are significant differences in views about the direction of causation. Orthodox/ marginalist view that causation runs from the rate of profit to the rate of interest This view embodied in orthodox treatment of saving and investment: I=f(i) i S, I S=f(i) S fu . reflecting rate of “time-preference” Interpreted by early and later marginalists as reflecting supply of “capital” in “free form” i.e. resources “set free” for provision of future consumption
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I fu . interpreted as demand for these resources of “capital in free form” Negative slope of I fu . seen to reflect diminishing productivity associated with adding larger quantities of “capital” to other factors (land, labour) => foundations for this view of the rate of interest lie in marginalist treatment of capital Key implications of the orthodox theory of the rate of interest: (i) Equilibrium interest rate is governed by equilibrium rate of return to capital
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