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In those heady student days, did you ponder the relationship between real capital and (oxymoronically) so-called "financial capital" (claims on real capital and/or its output)?

In find this to be ridiculously under-theorized, despite centuries of trying. Especially the vexing intersection of "fixed capital," total real capital (including human capital such as knowledge and skills?), and total assets/claims.

Even Piketty, who does flail at the problem here and there, punts and defines wealth and capital as synonymous.

Stiglitz and Milanovic have been going at this issue lately. I'd like to see a lot more of same. I're really like to see a section in Econ 101 texts: Wealth and Capital. It could be right next to the section titled Price Theory and Value Theory.

Thanks for listening, as always...

Steve: I can't remember, but I have pondered it a little recently. At the aggregate level, financial capital isn't capital. It's just bits of paper with promises written on them. But it looks like capital at the individual level. We can imagine an economy with no real investment and only pure consumption loans, where those loans are recorded on bits of paper. And we can imagine an economy with real capital, and bits of paper recording who owns what shares in that real capital. But if those bits of paper got lost, the real capital would still exist, the only difference is we would forget who owned it.

Capital is part of wealth, but not all of wealth. Land is wealth too (even if unimproved). Labour is wealth too (even if unimproved).

Nick: Thanks. Given economists' interest in property rights, I'd also like to see the concept of "ownership" interrogated more rigorously. Basically an exclusionary right--not so much what I can do with something as what nobody else can do with it...

On wealth, capital, and saving(s), you *might* find this interesting... http://www.asymptosis.com/is-gdp-wildly-underestimating-gdp.html

Steve: "ownership" is a fuzzy description of a whole slew of different rights, that are restricted in various ways to a greater or lesser extent. Some economists get into it.

On your post: I think Effem in the first comment had it right. Interest rates fell, so asset prices rose, quite apart from any saving.

'And is "capital" a thing, or is it just the name for a process of converting apples today into apples in the future? '

One way this process could work is by lending 100 apples for a year at 5% annual interest.

Another way is that I could buy a machine for 100 apples today, then rent that machine out for apples, and over a year get 105 apples back in revenue.

Or I could just have a magic box where I put my apples and a year later they have turned into 105 apples.

In all 3 cases I think the apples ARE the capital (at least at the start of the year). And the apples do sort of disappear from me during the year.

My apples are generating apple revenue for me so I feel like I should call this income. Its really not much different from the wage-income I get for renting out my human capital. In both cases I get rewarded for giving up control over my resources for a while.

MF: OK. But do we count those 5 bananas as income in my first example?

Well, If I can convert those 105 bananas back into 105 apples then its exactly the same story. If (as seems likely) the value of bananas has fallen then my 105 bananas will be worth less than 105 apples. Its still income but less in apple terms. If people have got carried away with the process of creating bananas then I may even make a loss.

I'm not sure what you are trying to get at here -- is this a Cambridge Capitalist Controversy argument? If not, just use the standard accounting tools to determine your income. E.g. if operating the machine costs you $1 and bananas sell for $1 each and apples sell for $1, then your income is $4. Questions such as "well if everyone did that, then the price would be X" are irrelevant. What is relevant is the prices realized by *you* when you made the transformation.

That means that other people may report different incomes for the same (physical) production, much like digging a barrel of oil out of the ground and selling it can give you $100 of income one month and $50 of income the next month.

Income is fundamentally a nominal quantity, not a real quantity, IMO. That you can divide it by a general basket of consumption goods and get some equivalent of consumption does not fundamentally change that. I.e. you can't measure income by looking at physical transformations alone. Once you are OK with that, then I think these questions go away, no?

MF: if the price of one apple is 1.0 bananas, then you would make a profit by using the technology. But if anyone can use the technology, the price of one apple will be 1.05 bananas, so there's no profit.

And, by the way, this goes back to the "fudge" by which economists view income as production of goods rather than as the sale of goods. You know that's a fudge, and it's usually harmless, but here is one case where the fudge bites.

rsj: "E.g. if operating the machine costs you $1 "

The machine costs you nothing to operate. Except for the cost of the 100 apples you need to put into the black box to get 105 bananas out. There is no machine. The technology is knowledge, not a machine.

There is no money. It's a barter economy. There are only apples and bananas, and promises to deliver apples next year. Simplify. Money only messes with your head. Don't even think about the $ sign.

"Questions such as "well if everyone did that, then the price would be X" are irrelevant."

No they aren't. Because everyone *will* do that, if they know about the same technology, so prices will adjust.

The apple-banana conversion machine triggered an analogy in my mind. What if apples was a Canadian dollar and bananas was an American dollar. I could run one dollar through a washer/printer and easily make the conversion.

Then we would have:

Case 1. I would show a profit most of the time, but not always. No need to hold to the 1.05 to 1.00 ratio. As you say, if others tried the same thing, the ratio would soon be 1.00 to 1.00 as the relative supplies of Canadian and American dollars equalized.

Case 2. Just an instant version of Case 1. Everything would move faster.

Case 3. The interesting case! My $1 note is tied up for the year while the reprint machine works. At the end of a year, I make a profit.

To your questions:

Is this a "capital" thing? Well, I could not spend my Canadian dollar for one year so yes, I would have a capital investment. I worked hard to earn that dollar so I think I would have my property invested in the reprint process. My "capital" is invested.

Where did the capital go? It was "vanished" into the reprint processing machine but vanished with confidence that it would emerge one year later. I am thankful that I own the machine because I can carefully protect it. I don't want to lose my machine AND capital.

Agh, the marvels of printing!


If you convert apples to bananas but apples are valued more than bananas when you take them to market, then you have negative income, because you destroyed value. If bananas are valued more than you have positive income. How much depends on the price. This is not about money per se but about markets and preferences determining income so that you cannot just look at physical production to see what your income is.


Yep. You need to compare production to the relative price of apples to bananas. Now apply that same lesson to my case 3. What does it tell you?

It seems to me if just "I know a technolgy" is enough, there is no capital. There is capital if you have to embed that technology in a machine, and you can own that machine and rent it out to someone. In that case, the rent you get is capital income.

Of course, the "machine" could be an organization, or improved land, or some other subtle thing. But a literal machine will do to make point.

That seems to me to correspond to the usual meaning of "capital" in macroeconomic models. Am I missing something?

"Now apply that same lesson to my case 3. What does it tell you?"

I am a business with the machine that transforms 100 apples into 105 apples, but it takes 1 period for the transformation to occur. Suppose in Period 1, apples cost $1 and in period 2 apples cost $2 in the spot markets. The rate of interest is 10%. The machine can only be used once and disappears. I am going to round here.

If the household didn't buy the machine but got it for free, then their capital income is $100 (paid in period 2 on an investment in period 1). This machine will cost, on the open market, $91. And a household that invests in purchasing this machine will receive $9 in capital income because the interest rate is 10%.


Perhaps the source of the confusion here is that you think that because the interest rate is 10%, then you are not really getting any interest as you are indifferent between consuming in the present and consuming 10% more next period. Well, a worker may be indifferent between supplying labor and receiving labor income and not supplying labor and not receiving labor income. That does not mean that labor income does not exist, it only helps explain what the labor income in a given period happens to be.

rsj: lose the $ sign. We measure interest rates in apples. How may apples do I have to promise to pay you next year to get you to lend me 100 apples this year? If it's 105, then the (real) interest rate is 5%, and the price of one apple today relative to apples next year is 1.05.

And there is no machine, so it cost nothing to buy the machine. It's knowledge, not a machine.

And we can ask whether labour income exists too. But later.

It doesn't matter if you have the $ or not.

If I have to give you 2 apples this period in oder for you to supply 8 hours of labor this period, then I am paying you labor income of 2 apples.
If I have to give you 3 apples next period in order for you to defer consumption of 2 apples today, then I am paying you 1 apple in capital income.

Because these types of trades are made, both labor and capital income exist.


Sorry j I am being too literal and missing the point...

So I have a machine that turns 100 Brazilian Reals into 112 BRL in 1 year. It is called a Brazilian Bank. If I keep score of my income in USD, I might choose to use the BRL machine to do a carry trade (ignoring a few details such as onshore versus offshore markets). I borrow USD 100 for 1 year at 1 percent, convert to BRL at spot to get 235 or so BRL, and then make a one year deposit of the BRL at 12%. After that year is up, I will have net profit if the BRL has done better than a (roughly) 11 percent depreciation versus the USD. If the spot fx rate is still 235, I will have roughly an 11 % pretax profit after converting my BRL back to USD and paying off the USD loan
Could we use a "self funding" strategy to do the profit accounting equally well in bananas versus apples? I Borrow 100
apples, wait a year to get 105 through the machine, and then mark my income in my home currency of bananas?
Also, as an example, don't thousands of blast furnaces turn iron and coal into steel without eliminating the profit potential?

Again, sorry if j am missing the point

There's no labour. We can get to labour later. Apples and bananas just grow on trees, all by themselves. Some people own an apple tree, and have an income of 1,000 apples per year. Some people own a banana tree, and have an income of 1,000 bananas a year.

Now, if I know how to convert 100 apples into 105 bananas, and do it, do I have an income of 5 bananas? No. It depends on the price of an apple relative to bananas. If the price of one apple is 1.05 bananas, I get no income at all.

Now, if I know how to convert 100 apples this year into 105 apples next year, and do it, do I have an income of 5 apples?

Michael: there is no money, and no machines. Just apples and bananas, and the knowledge about how to convert one into the other. Wave a magic wand, if you like. But other people have the knowledge too.

Well in a world of magic there is no capital, but in a world of capital there is no magic.


Here is case 1: we have land or labour, or whatever, that can be used toproduce either apples or bananas. And if i divert land and/or labour away from apples into bananas, I produce fewer apples and more bananas. So let me simplify it. Forget about the land and labour, and suppose I can convert 100 apples into 105 bananas. It's the same.

Here is case 3: I can divert resources away from producing apples today to building capital goods, that let us produce more apples in future. So let me simplify it. Forget about the capital goods, and suppose I can convert 100 apples today into 105 apples next year. It's the same.

This is Production Possibility Frontiers 101. Apples on one axis; bananas on the other axis, and a downward-sloping PPF. As we move along the PPF we get fewer apples and more bananas. Now replace "bananas" with "apples next year".


Ahh, OK. Sure -- this was in my example. The value of the firm (or of the machine) is the difference between the cost of 100 apples in period 1 and the present value of 105 apples in period 2. If this value is zero, the machine is worthless. But if the machine is worthless, then it is not put into use.

All firms that are not bankrupt -- e.g. all machines that are put into use -- have some positive value. They are able to borrow at the risk-free rate to purchase their variable inputs, produce for a period of time, sell their outputs and bay back the loan. They have some positive money left over to pay the owner of the fixed inputs. The market price of the firm or of the fixed inputs is that stream of earnings discounted at the risk-free rate. In equilibrium, those fixed inputs will cost that discounted value so that the owner of the firm will receive capital income equal to the risk free rate on their investment. In disequilibrium sitatuations or with risk, the owner may well lose money on their investment and not even get the purchase price of the machine back.

I'm not sure what this has to do with the existence of capital income.

And if the machines are raining down from the sky on everyone, then the relative prices will change so that they become worthless.

On the other hand if the machines cost 1 apple. Then households will keep buying them up until the return of the machine is the risk free rate. In which case the capital income received by households will be the risk free rate * price of machines.

However you slice it, you get capital income equal to the amount of capital times the risk free rate.

rsj: "On the other hand if the machines cost 1 apple."

Now stop and think. Why would a machine cost 1 apple? Maybe because you converted 1 apple into a machine? Or used the resources that could have produced 1 apple to instead produce 1 machine? And then suppose the machine produces 1.05 apples next year, then dies? OK, now make the machine 100 times bigger. So there is an input of 100 apples this year, and an output of 105 apples next year? What happens in between, and whether it's a machine or an apple tree, doesn't matter. So now we can forget about the godamm machine?

The machine is just a reification of a capitalistic process. Forget about the damn machine, and think about the process. 100 apples go in one end of the process, and 105 apples come out the other end of the process one year later.


Why the hell did you introduce the machine if you want to forget about it? Equivalently, let's say that the interest rate is 5% too, so the machine does nothing for you at all. You are indifferent between picking up a machine from the side of the road and operating it for 1 period, or between just buying an IOU that pays 5%. The introduction of the machine does nothing for the economy.

Nevertheless your capital income is 5% times whatever you save. That is how much you need to be paid to defer consumption from one period. That payment is a real payment of income to you, just like a payment for providing labor is a real payment.


Since I contributed to your frustration I will try on your terms. Capital is a thing. If a process creates increase and in so doing eliminates scarcity and profit then it is not capital. If it goes on forever because some wand jockeys confuse increase for profit it could influence relative prices but it is still not capital. If no rational party would bother with it ever it is not capital. If the secret is lost due to disuse it might become capital again one day.

rsj: YOU introduced the machine!

I use the market to swap 100 apples for 105 bananas. Is my income 5 bananas?

I use the market to swap 100 apples this year for 105 apples next year. Is my income 5 apples next year?

LOL. Really? OK, I am doing something very tedious at work now, so I don't know if I introduced the machine or not. I thought you introduced the machine.

If you sell a promise to pay 105 apples next period in exchange for 100 apples today, then you are a borrower and are paying capital income.
If you buy a promise to pay 105 apples next period in exchange for 100 apples today, then you are a lender and are receiving capital income.

If you sell 10 apples for 10 hours of work, then you are an employer and are paying labor income.
If you buy 10 apples for 10 hours of work then you are a worker and are receiving labor income.

In all of the above cases, we can say that this is the result of voluntary exchange, so all parties think they are getting something that, on the margins, gives them equal value to what they are giving up. That does not contradict the fact that a transaction is occurring.

rsj: whatever time-zone are you in?

"If you buy a promise to pay 105 apples next period in exchange for 100 apples today, then you are a lender and are receiving capital income."

Now run it through with bananas.

If you buy a promise to pay 105 bananas today in exchange for 100 apples today, then you are a banana buyer and are receiving banana buyer income.

(Yes, we can make a similar point about labour income, in swapping leisure for apples, but set that aside for now. The whole concept of "income" is problematic.)

I'm in San Francisco!

I don't see the problem here. If you have nothing to eat, then you need to eat. You can't wait until period 2. That is fundamentally different than having only bananas to eat in period 1 and wanting to mix it up by substituting bananas for apples in period 1.

The story here is about wealth inequality. First, with high levels of inequality, the rich, who would not consume all their endowment in a single period anyways, are not really giving anything up to lend -- that would even be the case with a variety of negative interest rates. Second, even though the risk free rate is at zero, the capital share of income is still going up, which is really crazy. So there are a lot of real concerns here that deserve to be taken seriously. Sure, you can concoct a story in which borrowers and lenders are in some sense equal, but that's just assuming away the real economic problems that people are facing.

I don't think the notion of income is problematic at all. Like everything else, it can get a little fuzzy around the edges, but there is an important insight here that should not be erased by trying to play with the language.


Income is fundamentally a nominal quantity, not a real quantity, IMO. That you can divide it by a general basket of consumption goods and get some equivalent of consumption does not fundamentally change that. I.e. you can't measure income by looking at physical transformations alone. Once you are OK with that, then I think these questions go away, no?

I don't think income is a nominal quantity. It's just that the attempt to compare incomes via a common value measure may require nominal value measures.

If I am paid for some work with 1000 apples and 500 bananas, then my income consists of 1000 apples and 500 bananas.

Great example Nick. As for rsj and other people who do not get it really try to stop thinking about it in a way where there is a $ sign. I think the key to understanding what Nick may try to say is thinking the free good example. It will try to abandon the concept of selling one good for another and try it in a way where we just have one good.

Example 1: You start with one seed, then you plant the seed into rented land and some time later you have harvest of 10 seeds. Your "profit" is exactly 9 seeds in some combination of capital and labor income. Ten seed is result of hard labor and scarce land.

Example 2: Imagine that everyone has technology similar to that of Star Trek replicators and you can basically get all simple things absolutely costlessly. It works in a way that you put something into the machine and it takes some time to make 9 additional copies of that thing. You can even replicate replicators so replicators and all its products are really costless. Now if I use such a replicator to multiply number of seeds from 1 to 10 should it be considered some sort of capital/labor income even though it produces exactly the same seeds as in old times where labor and land was needed?

And here the crucial part is what Nicks says in second half of his example - it is not multiplying products, or increasing utility that we consider as capital income. If I know a joke that I effortlessly told to 100 people over the internet I did not earn some sort of capital income on that joke even though some of those people may invite me for a beer or something in return for me being such a funny guy.

For capital income to exist it is not sufficient to transform goods or produce more of the same goods or to increase utility. And it is valid even in a case where the thing that we produce is not "free" good - all it takes is that everyone can do the same thing that we do. We need some sort of monopoly power to create capital income. This monopoly may stem from us being the only ones who know some technology etc.

I think we have to start with a concept like the capacity to generate value. Then we note that, sometimes, part of the capacity to generate value consists in the control of things that can be employed in various ways in a value-generating process, and can transferred from one controller to another. When that control is institutionally recognized and regulated, it is ownership, and the ownership of things that constitute part of the capacity to generate value is capital.

Without some concept of ownership, the concept of capital as it is conventionally understood has no application. I agree that "ownership" is a semantically complex term with flexible and imprecise boundaries that covers a varied lot of institutional control relationships. But "capital" has very much the same complexity and imprecision. We shouldn't expect a definiens to be any more precise than the definiendum it defines.

Prof Rowe,

I feel like there is a problem with the entire concept of income in both case 1 and 2 because there are no time periods in the math. Then time is introduced in example three and we are asked which of the other two 'incomes' the first actual case of income most closely resembles.

In case 1, time is hinted at. For an unspecified period of time one can wring true profit from the technology for a limited time or quantity of production but we see that without monopoly power at some point the profits will end. So perhaps in a more fleshed out version of this case we would see something closely resembling income enough to make it worth comparison.

In case 2 time is gone entirely, and so is income.

gain over time is at the core of the concept of income. In a barter economy where trade and production occur instantaneously 'income' is a meaningless concept. But this seems to prove too much.

Anyway, this discussion may be above my level, so I'm sorry if I've missed your point.

In my view, J.V., Dan, and Nick Y all have good "morning after" comments. Three perceptions of the complexity of communicating economic concepts, and all nicely illustrating certain aspects.

I offered my "two cents" earlier, today I just say 'thanks' for expanding my economic horizons.

Nick Y: Imagine a world with continuous time, if you like. In all 3 cases a steady flow of 365,000 apples per year appear on the trees, and a steady flow of 365,000 bananas per year appear on the trees. Those are income.

Now we consider the technology, where we can change apples into bananas, or apples into apples:

In case 1, the output of 105 bananas is instantaneous with the input of 100 apples. In case 2 the output of 105 apples is instantaneous with the input of 100 apples (so you can create an infinite number of apples instantly, if you want). In case 3 time matters. The output of 105 apples is delayed 1 year after the input of 100 apples. You have to wait one year before you can eat the extra apples. (Of course, if you were infinitely patient, it wouldn't matter).


In your 09:17 comment, it seems to me that in each case there is an initial consumptive use of 100 apples. If the 100 apples do not exist, the process can not happen.

A second precondition also is found here. It takes an objective decision to initiate the conversion process, and presumably the initial apples must be collected, both events requiring an intelligent hand.

Would it be fair to say that the initial 100 apples became 'capital' when the decision was made to use them in a consumptive fashion?

Would it be fair to say that 'labor' was required to make the decision of conversion? Most would agree that 'labor' was required to gather the initial apples.

And finally, is it fair to say that ownership of the replicated apples in case 2 should belong to the owner of the replication process, or to the labor of the apple gatherer, or to the owner of the initial apples, or to the decision maker?

Prof Rowe,
Helpful! The trees are now capital I think. When you use your technology in case three you are planting a new tree. capital has formed? Then you get income from it.

Although I'm having the uncomfortable feeling that my next step is to say capital formation reduces the returns to capital and the market is doomed to consume itself ...

What about the energy consumed for the conversion? Is it more or less than +5 units?

In the case of seeds, the energy is from the sun. Profit is from the sun.

How about: Technology that takes 100J of energy and produces 105J of energy (should we ignore the thermodynamics?). Are the five units of energy profit?

Roger: "In your 09:17 comment, it seems to me that in each case there is an initial consumptive use of 100 apples."

"consumptive"? They don't have TB. And nobody is *eating* the 100 apples. They are *subtracted* from consumption. We consume 100 apples less (and 105 bananas more).

lmc: "What about the energy consumed for the conversion? Is it more or less than +5 units?"

units of *what*? We don't measure energy in apples or bananas.

Plus, more importantly: and what about the kitchen sink that is used to wash the apples and bananas before they are eaten?? The whole point of simple models is to NOT throw in the kitchen sink.


Sorry to beat a dead horse. It is fine to say my simplified model uses a candidate for capital that requires no other inputs and no improvement to create increase, and it is fine to say my model is a reification (I had to look it up) of capitalism. But if you say both, then a few of your loyal, frustrating readership will ask some questions. We are not merely being dull witted in insisting on the kitchen sink as a fixture of your core apple model, we are trying to work out how your simplified model can be applied to the world. Speaking for myself, if your simple model had eliminated all supernormal profit instead of all profit, I would have immediately understood. But your simplified model is in fact impossible. In every real world game I need some minimum profit to use the technology, and so profit can never really be zero. But then there would be no question of capital since if it is deployed it is capital. I do not need to be a monopoly I just need a low hurdle rate in a game with no cost to entry.

I not going to post again for a long while, but I will be reading and learning from your blog.

(Promises, promises)


Michael: ". In every real world game I need some minimum profit to use the technology, and so profit can never really be zero."

rsj was getting hung up on that old chestnut too. There are zero opportunity costs of running this process, just the 100 apple input. So if the price of apples is 1.05 bananas, the *individual* competitive "firm" is indifferent between any level of output, including zero, because they all give zero ("supernormal") profits. But the *aggregate* output of all firms is pinned down by the demand and supply of apples and bananas and the aggregate conversion of apples into bananas that gives a price of 1.05.

This is exactly the same (non-)issue we get in ECON 1000 when individual firms in a competitive market have long run constant returns to scale. We can solve for the market quantity of widgets produced, but we can't say how many widgets each individual firm will produce. But it doesn't matter. So what if one firm expands and another contracts by the same amount. And if you want to say that firms must earn a vanishingly small crumb of banana just to be bothered, OK. De minimis non curat lex economicus, or something. I have a constant returns technology here, to keep it simple. 200 apples can be converted into 210 bananas.

Of course, there does exist a technology that turns 100 apples into 105 apples instantly. It's called a 'firearm'.

And no, that was not intended to be a non sequitur. Think about it.

Fred: funnily enough, I had been thinking about that too. It's capital from the POV of the owner, but not from the POV of the whole economy. "Rent-extraction capital"? If you think of lawyers as predators, their human capital is like that.


No, I was misquoted! E.g. assume that there are N such machines, each converting 100 apples into 100 + N apples _if_operated. Now, what happens when the rate of interest falls? Capital Income goes up (because more such machines are operated). When the rate of interest increases, capital income falls. In particular, at the zero (real) bound, we would be in the paradoxical situation of households being happy with 0 capital income yet receiving the greatest amount of such income. The only difference is that they receive no income from their bond holdings, but large amounts of income from their holdings of equity (similar to our current low IR environment).

At the same time, when real interest rates are high, households may want more capital income but in aggregate receive less. They get the majority of their capital income from their bond holdings and holding equities sucks.

In any case, I am still waiting for the blog that argues, using exactly the same logic, that labor income does not exist, either.

rsj: I'm thinking about doing it, but the point is sort of obvious and boring. Leisure is a good, which should be counted as part of income, so converting leisure into apples doesn't create income. It just converts income from one form into another. But then some people are (say) stronger, and can convert 1 hour's leisure into more apples than weaker people, so their income is higher.

Yes, giving up leisure for labor is exactly like giving up present consumption for future consumption. And yes, most people who give up leisure for a lot of money would probably want to give up for very little because they enjoy working, just as most people who give up present for future consumption would want to do the same because they enjoy accumulation. Neither enjoyment is modelled in mainstream models that I am aware of, although in some cases some models assume inelastic labor supply and I've seen some desperate pleas to put wealth into the utility function.

I agree that both arguments are obvious consequences of Arrow-Debreu but not particularly convincing as a description of what is happening in actual economies. Except that the two mirror arguments are disturbing to two mirror groups and you only chose to disturb only one. That selective argumentation is the most non-obvious and interesting part of this whole discussion.

rsj: nope. The analogue would be: if a clever person know about a technology that converts apples into twice as many bananas (or future apples) as anyone else's technology, and keeps that technology secret, and makes profits from his monopoly power, that person would be wealthier, just like the strong worker.

Knowledge is non-rival; worker strength is rival.

Is this just saying that with perfect competition (i.e. no secrets), all forms of capital must have gross returns equal to the rate of interest, and hence on net can generate no income (to the individual capitalist)? Same as in perfect competition, no firm can make economic profit?

Nive: From that perspective, I'm asking the question: is interest income really income?

Take a model where every individual has 100 hours of labour (or land). And each individual can choose between 4 things (in any mix):

1. Consume 100 hours leisure

2. Produce and consume 100 apples today.

3. Produce and consume 105 bananas today.

4. Produce and consume 105 apples next year.

(Or any mix of the above).

Different individuals will make different choice, depending on their preferences. Why would we say that an individual who chooses 4 has higher income than an individual who chooses 2?

I would say they are all have the same income.

Is there no standard definition of income? I'm sure someone has thought about this before :)

I initially thought income should be defined as what you can consume, regardless of what you actually do consume. This looks like it would work nicely for 1-4 in the first period. Assuming all are price-takers, and 1 apple = 1 leisure-hour = 1.05 bananas = 1.05 apples tomorrow, they all can consume 100 apples today, so their income is 100 apples.

This does not seem to work very well in succeeding periods once you introduce savings. If #4 saves all his apples today to get 105 apples next year, and also produces 100 apples next year, we surely don't want to say his income next year is 205 apples. Should we subtract 100, what he saved; or 105, the future value of his savings, or something else? What if he did have a secret technology, so he could produce 110 apples, is his income in the first period 110/1.05, or do we count the extra 5 apples as his second-period income?

These sort of issues look pretty similar to the issues of income accounting for a firm. What sources of income should be accrued, what should be marked to fair value etc.

From my biased point of view (working in finance), fair-value accounting together with the definition of profit & loss for a trading book would be the easiest to make consistent. For 1-3, initial wealth = 100+100/1.05. When we go from year 1 to year 2, p&l = 100 (realized) + 100 (unrealized) - (100-100/1.05) (funding) - (100+100/1.05) (yesterday) = 0. For #4, assuming he produces 100 apples next year the same as #2, in addition to the 105 coming from his investment, the breakdown is a little different, but he has the same initial wealth and p&l: 105/1.05 + 100/1.05 wealth, p&l = 105 + 100 - (205-205/1.05) - (105/1.05+100/1.05) = 0.

This does lead to the odd result that if everything is deterministic, income is always zero.

In the trading book p&l view, interest income is not really income unless it exceeds your cost of funding, by the way -- that's why we subtract funding.

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