The Marginalist Approach to Capital

Efforts to counter the view of the origin of profits emerging from the surplus approach are present already in Ricardo’s time and increase afterwards. Around the middle of the nineteenth century, John Stuart Mill declares himself a Ricardian but accepts the combination of Senior’s abstinence with a wage-fund approach to capital as a justification of profits.

The distinguishing element of the marginalist approach is the conception of pro­duction as the cooperation of “factors of production” substitutable one for the other through two mechanisms of substitution activated by changes in relative factor rentals: a direct or technological mechanism, based on the tendency of firms to change the pro­portion in which factors are combined in favour of the factor that becomes relatively cheaper; and an indirect mechanism, based on changes in relative industry dimensions due to the tendency of consumer demand (at least in the absence of “perverse” income effects) to shift in favour of the consumption goods that become relatively cheaper because their production employs in greater-than-average proportion the factor whose rental decreases.

Such an approach treats capital as another factor of production, whose reward, the rate of interest, is determined by the same substitution mechanisms that deter­mine the reward of (each kind of) labour and land. However, capital is different in that it is physically heterogeneous and yet tending to a uniform rate of reward, so its insertion in the above theoretical structure is not easy; indeed it is done in a number of different ways that are distinguished below, all however having in common that capital is brought about and maintained by acts of saving, that is, of abstinence from immediate consumption; that more capital allows the same quantity of labour and land to produce more; that, because of this, abstinence has an indirect marginal utility which is what the rate of interest measures. This can be contrasted with the surplus approach, where the uniform rate of profits and prices of production have the sole function of allowing all units of capital equally to share in the total profits due to the capitalists’ collective capacity to limit real wages - equally to share in the plunder, as a Marxist would put it.

The view of interest as the rental of a factor motivates its inclusion in the cost of pro­duction; “profit” is redefined to mean the excess of capital’s net yield over the normal rate of interest, and therefore as tending to zero (apart from the reward for risk-taking) in the long period. We will maintain the classical meaning of “profit”.