Economics Dictionary of ArgumentsHome
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| Rate of return: In economics, the rate of return is the percentage gain or loss on an investment over a specific period, relative to its initial cost. It measures profitability and efficiency, encompassing income (e.g., dividends, interest) and capital appreciation. It is crucial for comparing investment performance and guiding financial decisions. See also Returns to scale, Profit._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Dictionary of Arguments. | |||
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Luigi Pasinetti on Rate of Return - Dictionary of Arguments
Harcourt I 159 Rate of return/Fisher/Pasinetti/Harcourt: Pasinetti(1) distinguishes two meanings of Fisher's 'rate of return on sacrifice' or 'rate of return over cost'. a) The first is the rate of interest at which two techniques (options, projects, going concerns, economic systems) are equi-profitable, i.e. that rate of interest which when used as the discount factor equalises the present values of two alternative streams of expected receipts (Fisherian incomes) and expenditures - call it RF1. >Franklin Fisher. b) The second relates to the ratio of the expected increase in perpetuity in the production of a commodity to the withdrawal from consumption or other uses of the present annual flow of the commodity, the withdrawal or sacrifice being needed to make the investment that will make the increase in production possible. If we assume that all prices and the rate of profits are given, this may be expressed as a ratio of physical quantities - the expected increase in production over the necessitated withdrawal now from the current production stream, a saving which may then be translated at a constant price ratio into the necessary investment. Harcourt I 160 Call it RF2 and notice that we get a choice of technique rule - the project is or is not worth doing according to whether or not RF2 is greater or less than the current rate of interest (or profits). >Reswitching/Economic theories. Example: Pasinetti's distinction between the two concepts may be illustrated by the following example. Consider a going concern, say, an enterprise that produces a given rate of output using a given set of capital equipments and a given labour force. If we know the current level of prices, including the real-wage rate (and we make the usual assumption that current events are expected to continue into the future), clearly we could estimate the concern's current rate of profit. Now suppose a new opportunity arises. Harcourt I 161 The enterprise uses some of its current output to save and invest in the equipment associated with the opportunity. We suppose - vitally - that all prices remain unchanged. As a result of installing the equipment the level of output rises. With unchanged prices, the increment of output per period may be related to the saving (equals investment) that brought it about and, thus, the value of RF2 calculated. In general the value of RF2 will not equal the rate of profit of the going concern before the opportunity arose. Now it might be that in the economic system as a whole there exists a constellation of wages, prices and the rate of profits at which both the old and, now, the new situation of the enterprise would look equally profitable to the enterprise. There is no necessity about this and probably, in general, no such constellation exists. Even if it does exist, however, the rate of profit at which the two situations are equi-profitable would not coincide with the old rate of profit, or with the new one, or with the value of RF2 calculated for the change. Fisher introduces the infinite options case in which diminishing returns prevail - given sacrifices now lead to successively smaller and smaller permanent increments of production - and suggests that we will choose the option at which the marginal rate of return on sacrifice equals the rate of interest. Moreover, his marginal rate of return on sacrifice when applied to the economy as a whole tends 'to the traditional notion of a marginal product of capital' and, Pasinetti [1969](1), p. 511, claims, 'represents something which is not only independent, but actually a determinant, of the rate of profits.' He refers the reader to the following passage in Fisher [1930](2), p. 176. Harcourt: We can scarcely exaggerate the importance of the concept of 'rate of return over cost' and of its special variety 'marginal rate of return over cost' as an element in our account of the conditions determining the rate of interest. It supplies, on the physical or technical or productivity side of the analysis, what the marginal rate of time preference supplies on the psychical side. Fisher's examples relate to individuals but Pasinetti takes it that their application is to be wider, i.e. to the whole economy. Dealing with individuals in situations of perfect competition allows us, of course, to treat prices and rates of profits as given. The critics of neoclassical analysis suggest that this reasonable assumption ceases to be so when we deal with the whole economy because, then, any change of r, no matter how small, changes the whole pattern of relative prices, see Pasinetti [1969](1), p. 511. But at a switch point relative prices are constant, otherwise it would not be possible for two equi-profitable techniques (eco- nomies, islands of stationary states) to co-exist in different proportions: see Samuelson [1961](3). Harcourt I 162 PasinettiVsSamuelson: But Pasinetti's interpretation of Fisher's arguments takes us further than a consideration of the switch-point case: (…) one technique only is the most profitable at any given value of r. 1. Pasinetti, L. L. [1969] 'Switches of Technique and the "Rate of Return" in Capital Theory', Economic Journal, LXXIX, pp. 508-31. 2. Fisher, Irving [1930] The Theory of Interest (New York: Macmillan). 3. Samuelson, P. A. [1961] 'A New /Theorem on Nonsubstitution', Money Growth and Methodology, published in honour of Johan Akerman (Lund Social Science Studies, Vol. 28) (Lund: C. W. K. Gleerup), pp. 407-23._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. "Vs" indicates differences in content, not necessarily the chronological progression of a controversy. If a German edition is specified, the page numbers refer to this edition. |
Pasinetti I Luigi L. Pasinetti Structural Change and Economic Growth: A Theoretical Essay on the Dynamics of the Wealth of Nations Cambridge 1983 Harcourt I Geoffrey C. Harcourt Some Cambridge controversies in the theory of capital Cambridge 1972 |
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> Counter arguments against Pasinetti
> Counter arguments in relation to Rate of Return
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