Capital Immobility, Adjusted Costs, and the Theoretical Foundations of Income-Expenditure Models

In an analysis of the theoretical relationships between capital-market equilibrium and the investment behavior of firms, the relative price of capital and consumer goods and the real rate of interest are required to equal the technical rates of transformation. Further, it is assumed that there are increasing marginal costs of introducing new capital goods into production and that all capital stock is confined to specific sectors. Any adjustments in internal costs modify the results of the model since these costs are additional to production costs of new capital and therefore represent a fundamental change in the nature of the production process. Standard fiscal policies may not change aggregate demand in the direction predicted by the IS-LM approach. To judge what outcome is most likely requires considerable information about an economy's structure of production.