Investment Behavior and Neo-Classical Theory

Abstract

p HE role of relative prices as determinant of factor demand has received wide attention in recent work. Major contributions 1 have been made by Dale W. Jorgenson who, either alone or with associates, has presented, along with various empirical results and certain policy conclusions, what is called a theory of investment behavior based on the neo-classical theory of optimal accumulation of 2 We shall endeavor in this paper to direct number of tests to critical points of departure in the Jorgenson model. This task has been greatly facilitated by Jorgenson, who has made available to us his own basic quarterly data for total United States manufacturing, thus permitting our re-examination to go forward without confusing the analysis with questions of data comparability.3 The essential burden of Jorgenson's argument is that substitution parameters have been improperly neglected or ignored in most work on the investment function. He accepts the widely held view of the demand for capital stock as function of the output produced but argues that it is also function of the relative price of output and capital. Investment itself then consists of the replacement of depreciating capital stock and distributed lag adjustment of capital to its (usually changing) equilibrium value. Jorgenson also argues that, in quarterly data at least, particular generalization of the techniques by Chenery and Koyck for estimating distributed lag relations is essential. Jorgenson seeks to capture the price or substitution effect in investment with various measures of, or proxies for the implicit rental or 'shadow price' of unit of capital services. ' In his original formulation 5 this depends upon the price of capital goods, q, the rate of depreciation, 8, the rate of interest, r, the relative rate of change of capital goods prices, q/q (capital gains), the rate of direct business taxation, u, and the proportions, v, w, and x, of depreciation, cost of capital, and capital losses (gains) chargeable against taxable income; his rental price for capital services is