CAPITAL THEORY AND INVESTMENT BEHAVIOR.

There is no greater gap between economic theory and econometric practice than that which characterizes the literature on business investment in fixed capital. According to the neoclassical theory of capital, a production plan for the firm is chosen so as to maximize utility over time. Under certain well-known conditions this leads to maximization of the net worth of the enterprise as the criterion for optimal capital accumulation. Capital is accumulated to provide capital services, which are inputs to the productive process. By contrast, the econometric literature on business investment consists of ad hoc descriptive generalizations such as the capacity principle, the profit principle, and the like. The purpose of this article is to present a theory of investment behavior based on the neoclassical theory of optimal accumulation of capital. Of course, demand for capital is not demand for investment. The short-run determination of investment behavior depends on the time form of lagged response to changes in the demand for capital. For simplicity, the time form of lagged response will be assumed to be fixed. At the same time a more general hypothesis about the form of the lag is admitted than that customary in the literature.