Value and Capital
Encyclopedia
Value and Capital is a book by the British economist John Richard Hicks, published in 1939. It is considered a classic
exposition of microeconomic theory. Central results include:
It begins with a simplified case and generalises from it. An individual consumer has a given money income for spending on only two goods. What determines quantity demanded of each good by that individual? The basic hypothesis
is the set of restrictions on the utility function and demand equilibrium that results as to the consumer's budget constraint. That hypothesis drives the theoretical outcome of a price change in one of the goods on the quantity demanded of each good. The book decomposes the change into the substitution effect and the income effect. The latter is the change in real income in theoretical terms without which the distinction between real and nominal values would be more problematic. The two effects are now standard in consumer theory
. The analysis conforms with a proportionate change in money income and money prices of both goods leaving quantity demanded of both goods unchanged. This is also consistent with the distinction between real and nominal values and represents
a common hypothesis in economics of no money illusion
.
An appendix generalises the 2-good case for consumption to the case of one good and a composite good
, that is, all other consumer goods. It derives the conditions under which the demand properties in equilibrium as to the price ratio and the marginal rate of substitution
attributed to the 2-good case apply to the more general case, allowing the neat distinction between the income effect and the substitution effect.
In his Nobel lecture, Hicks cites Value and Capital for clarifying an aspect of what became known as the aggregation problem
. The problem is most acute in measuring the capital stock by its market value for the real-world case of heterogeneous capital goods (for example, steel presses and shovels). He showed that if the price ratios between the goods (equal to their marginal rates of substitution in equilibrium) did not remain constant with additional capital, aggregation of capital-good values would not be a strictly valid measure of the capital stock. He also showed that there was no unambiguous way of measuring the "period of production" (proposed by Böhm-Bawerk) that would in general serve as a measure of the capital stock.
From consumer equilibrium for an individual, the book aggregates to market equilibrium across all individuals, producers, and goods. In so doing, Hicks introduced Walrasian general equilibrium theory to an English-speaking audience. This was the first publication to attempt a rigorous statement of stability conditions for general equilibrium. In doing so, Hicks formalised comparative statics
. The book synthesises dynamic-adjustment elements from Walras
and Wicksell
and from Marshall
and Keynes
. It distinguishes temporary, intermediate, and long-run equilibrium with expectations as to future market conditions affecting behaviour in current markets (Bliss, 1987, pp. 642–43).
Classic book
A classic book is a book accepted as being exemplary or noteworthy, either through an imprimatur such as being listed in any of the Western canons or through a reader's own personal opinion. The term itself is closely related to Western Canon and to various college/university Senior Comprehensive...
exposition of microeconomic theory. Central results include:
- extension of consumer theoryConsumer theoryConsumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...
for individual and market equilibrium as to goods demandedSupply and demandSupply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
with explicit use of only ordinal utilityOrdinal utilityOrdinal utility theory states that while the utility of a particular good or service cannot be measured using a numerical scale bearing economic meaning in and of itself, pairs of alternative bundles of goods can be ordered such that one is considered by an individual to be worse than, equal to,...
for individuals, rather than requiring interpersonal untility comparisons - analysis of the 2-good as to effects of a price change and mathematical extension to any number of goods without loss of generality
- parallel results for production theory
- extension of general equilibrium theory of markets and adaptation of static-equilibrium theory to economic dynamics in distinguishing temporary and long-run equilibrium through expectation of agentsAgent (economics)In economics, an agent is an actor and decision maker in a model. Typically, every agent makes decisions by solving a well or ill defined optimization/choice problem. The term agent can also be seen as equivalent to player in game theory....
. `
Outline and details
The book has 19 chapters and the following outline:- Introduction
- Part I, The theory of subjective value
- Part II, General equilibrium
- Part III, The foundations of economic dynamics
- Part IV, The working of the dynamic system
- Mathematical appendix.
It begins with a simplified case and generalises from it. An individual consumer has a given money income for spending on only two goods. What determines quantity demanded of each good by that individual? The basic hypothesis
Hypothesis
A hypothesis is a proposed explanation for a phenomenon. The term derives from the Greek, ὑποτιθέναι – hypotithenai meaning "to put under" or "to suppose". For a hypothesis to be put forward as a scientific hypothesis, the scientific method requires that one can test it...
is the set of restrictions on the utility function and demand equilibrium that results as to the consumer's budget constraint. That hypothesis drives the theoretical outcome of a price change in one of the goods on the quantity demanded of each good. The book decomposes the change into the substitution effect and the income effect. The latter is the change in real income in theoretical terms without which the distinction between real and nominal values would be more problematic. The two effects are now standard in consumer theory
Consumer theory
Consumer choice is a theory of microeconomics that relates preferences for consumption goods and services to consumption expenditures and ultimately to consumer demand curves. The link between personal preferences, consumption, and the demand curve is one of the most closely studied relations in...
. The analysis conforms with a proportionate change in money income and money prices of both goods leaving quantity demanded of both goods unchanged. This is also consistent with the distinction between real and nominal values and represents
Mathematical problem
A mathematical problem is a problem that is amenable to being represented, analyzed, and possibly solved, with the methods of mathematics. This can be a real-world problem, such as computing the orbits of the planets in the solar system, or a problem of a more abstract nature, such as Hilbert's...
a common hypothesis in economics of no money illusion
Money illusion
In economics, money illusion refers to the tendency of people to think of currency in nominal, rather than real, terms. In other words, the numerical/face value of money is mistaken for its purchasing power...
.
An appendix generalises the 2-good case for consumption to the case of one good and a composite good
Composite good
In economics, demand for a good is often the focus as to a change in its price. A composite good is an abstraction used in economics that represents all goods in the relevant budget besides the one in question.-Purpose:...
, that is, all other consumer goods. It derives the conditions under which the demand properties in equilibrium as to the price ratio and the marginal rate of substitution
Marginal rate of substitution
In economics, the marginal rate of substitution is the rate at which a consumer is ready to give up one good in exchange for another good while maintaining the same level of utility.-Marginal rate of substitution as the slope of indifference curve:...
attributed to the 2-good case apply to the more general case, allowing the neat distinction between the income effect and the substitution effect.
In his Nobel lecture, Hicks cites Value and Capital for clarifying an aspect of what became known as the aggregation problem
Aggregation problem
An aggregate in economics is a summary measure describing a market or economy. The aggregation problem refers to the difficulty of treating an empirical or theoretical aggregate as if it reacted like a less-aggregated measure, say, about behavior of an individual agent as described in general...
. The problem is most acute in measuring the capital stock by its market value for the real-world case of heterogeneous capital goods (for example, steel presses and shovels). He showed that if the price ratios between the goods (equal to their marginal rates of substitution in equilibrium) did not remain constant with additional capital, aggregation of capital-good values would not be a strictly valid measure of the capital stock. He also showed that there was no unambiguous way of measuring the "period of production" (proposed by Böhm-Bawerk) that would in general serve as a measure of the capital stock.
From consumer equilibrium for an individual, the book aggregates to market equilibrium across all individuals, producers, and goods. In so doing, Hicks introduced Walrasian general equilibrium theory to an English-speaking audience. This was the first publication to attempt a rigorous statement of stability conditions for general equilibrium. In doing so, Hicks formalised comparative statics
Comparative statics
In economics, comparative statics is the comparison of two different economic outcomes, before and after a change in some underlying exogenous parameter....
. The book synthesises dynamic-adjustment elements from Walras
Walras
Walras is surname of:* Auguste Walras , French school administrator and economist* Léon Walras * Walras' law...
and Wicksell
Knut Wicksell
Johan Gustaf Knut Wicksell was a leading Swedish economist of the Stockholm school. His economic contributions would influence both the Keynesian and Austrian schools of economic thought....
and from Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...
and Keynes
John Maynard Keynes
John Maynard Keynes, Baron Keynes of Tilton, CB FBA , was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, as well as the economic policies of governments...
. It distinguishes temporary, intermediate, and long-run equilibrium with expectations as to future market conditions affecting behaviour in current markets (Bliss, 1987, pp. 642–43).