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Pg 191

-It was shown that today's profits depend upon today's investment
-profits equal investment
-investment is still the major, although not the only, determinant of profits
Investment outputs must be financed while being produced.
ownership of (or positions in) capital assets must be financed.
(remember both are diff)
-financing terms affect the prices of capital assets, the effective demand for i
nvestment, and the supply price of investment outputs
-determinants of investment help to understand financial instability theory
-the fundamental cyclical properties of our type of economy are determined by re
lations among
profits, capital-asset prices, financial market conditions, and investment
Pg 192
-An investment is like a bond; it is a money-now-for-money-Iater exchange, depen
ding upon how well the firm does, which in turn depends upon how well the indust
ry and the economy do
-workers producing investment output and the owners of the debt instruments
used to finance investment output have to be paid while the investment
output is gestating
-The money to make these payments by the
producers of components to an investment output has to be obtained either
from sources internal to the producing or investing firm or from outside
-A decision to invest-to acquire capital assets-is always
a decision about a liability structure
-Cash-flow commitments, present-value calculations, and liquid-asset holdings de
how developments in financial markets affect the behavior and the
viability of economic units
-that instability is determined by mechanisms within the system,
not outside it
Pg 193
-Instability emerges as a period of relative tranquil growth is transformed
into a speculative boom
-This occurs because the acceptable and the
desired liability structures of business firms (corporations) and the organizati
acting as middlemen in finance change in response to the success of
the economy
Pg 194
The fundamental propositions of the financial instability hypothesis are:
I. Capitalist market mechanisms cannot lead to a sustained, stableprice,
full-employment equilibrium.
2. Serious business cycles are due to financial attributes that are
essential to capitalism.
-In a capitalist economy, the means of production are
privately owned: the difference between total revenues and labor costs
provides income to the owners of capital assets.
-Furthermore, capital assets
can be both traded and hypothecated
-In addition, financial instruments resulting from hypothecating or pledging

means of production or future incomes can be traded

-Because capital and financial assets can be traded, they have prices
##(what are financial instruments, financial assets)##
A financial asset is an intangible asset that derives value because of a contrac
tual claim. Examples include bank deposits, bonds, and stocks. Financial assets
are usually more liquid than tangible assets, such as land or real estate, and a
re traded on financial markets.
A financial instrument is a tradable asset of any kind; either cash, evidence of
an ownership interest in an entity, or a contractual right to receive or delive
r cash or another financial instrument.
-These prices of capital assets and financial instruments, moreover, are
determined in markets
Pg 195
-The price buyers are willing to pay for investment is
derived from the income that the resulting capital asset is expected to yield
-The prices of capital assets and the way they are linked to the output
of investment goods are critical determinants of the behavior of a capitalist
-the income from
capital assets is divided between debt owners and the residual (equity)
-the prices of capital and financial assets depend upon the cash flows they are
expect to generate
-a capitalist economy depends upon capital income reaching a level in which capi
tal assets earn sufficient income to validate past debts
-There is an existence of two prices one for current o/p and the other for capit
al assets
-these two are determined in different markets, however they are linked, for inv
estment o/p is a part of current o/p
Pg 196
-Since our economy has corporations and stock exchanges, which deal
in the ownership of capital assets, the financial dimension of a corporate
capitalist economy is much greater than for an economy dominated by
partnerships and proprietorships
-By assuming that unemployment leads to wage and price deflation, an
increase in the price-level-deflated value of money balances will take place.
This, in turn, will lead to a rise in demand for consumer goods, which
boosts employment. This line of reasoning, known as the Patinkin resolution,
is the key to the emergence of the neoclassical synthesis.
-Prior to the
development of the Patinkin resolution, the following propositions,
attributed to Keynes, were widely accepted: (1) the product market is the
proximate determinant of the aggregate demand for labor, (2) at a given
money wage rate demand for labor can be less than supply, and (3) a decline
in money wages due to an excess supply of labor might not be efficient in
eliminating unemployment.
-These propositions really missed a critical point of both Keynesian
theory and our economy, which is that there are forces for change-which

we can call disequilibrating forces

-These disequilibrating forces may be weak at times, but they accumulate
and gather strength, so that after a while any ruling equilibrium will be
-periods oftranquility
-that tranquility is disrupted by investment booms, accelerating inflations,
financial and monetary crises, and debt deflations
-market reactions to unemployment, which lead to falling wages and prices, are i
in raising employment because there are inherited private debts that
can be validated only if money profits are sustained, and lower money wages
and prices lead to lower profits
-the cash flows required to
validate private debts would be forthcoming only if profits are sustained
-The Patinkin resolution ignores the effects of
bankruptcy upon asset prices and the adverse effects of bankruptcy on the
ability of private organizations to finance investment
-things are made worse by the affects of decreased profits, wages, and investmen
and the paralyzing effects of corporate reorganizations upon investment
-Only after the financial structure is
radically simplified, which may take many years, may falling prices be expansion
-they do not ask whether the
equilibrium so defined contains ongoing processes that will cause it to be
-The ongoing processes tend to rupture a
full-employment equilibrium in an upward direction; that is, once full
employment is achieved and sustained the interaction among units tends to
generate a more than full-employment speculative boom
-In an economy in which the debt
financing of positions in capital and financial assets is possible, there is an
irreducible speculative element, for the extent of debt-financing of positions
and the instruments used in such financing reflect the willingness of
businessmen and bankers to speculate on future cash flows and financial
market conditions
Pg 199
-Each new type of money that is introduced or an old one that is used
to a greater extent results in the financing of either some additional demand
for capital and financial assets or of more investment
-This results in both a higher price of assets, which, in turn, raises the deman
d price for current
investment, and increases the financing available for investment
-An investment boom leads to inflation, and inflationary boom leads to a financi
al structure that is conducive to
financial crises
Pg 200
-capital assets used in production are expected to yield
income in the form of quasi-rents Qi
-Quasi-rents are the difference
between the total revenue from selling output produced with the aid of
capital assets and out-of-pocket, running, or technically determined costs
associated with producing output; they are a gross-profits concept.
-Such a price in excess of out-of-pocket costs is due to the scarcity of the out
and therefore of the capital assets needed to produce the output

-capital assets are valuable only because

they earn profits
-prices of current output(and hence the investment output) depend upon money wag
rates, the productivity of labor with the existing capital assets, and the
markups on technologically determined labor costs that are sustained by
demand and that reflect the business style of the economy
-Capital-asset prices on the other hand are determined by supply and
demand in markets in which the supply is fixed in the current period and
demand reflects the value placed upon the cash (or the quasi-rent)
-The market price of a capital asset that is a substitute
in production for an investment output must be equal to, or greater
than, the supply price of the investment good if the investment good is to
Pg 201
-financial assets are much like
capital assets in that ownership entitles one to a stream of cash
-the price of a unit
of money is always a dollar, so that the price paid for the protection a dollar
yields cannot vary. However, the value of the protection that a dollar yields
can change. When this happens, the price of alternatives to holding
money-that is, the price of other assets-must change
Pg 202
-all financial and capital
assets have two cash-flow attributes. One is the money that will accrue
as the contract is fulfilled or as the capital asset is used in production;
the second is the cash that can be received if the asset is sold or pledged
-The price, PK , of any capital asset depends upon the cash flows that
ownership is expected to yield and the liquidity embodied in the asset
-Smilar with price of a financial asset
-with a given perception of expected cash flows and uncertainties
embodied in various financial and capital assets, the dollar is
plentiful relative to the stock of assets, then the price of assets will be high
the prices attached to capital and financial assets will tend to be higher the
greater the quantity of money
(Three cases --see the book)
c)elastic demand for liquidity
d)special case: price falling as money supply increases
Pg 204
-the function shifts as experience changes expectations of the cash flows
that capital and financial assets will yield
-A rise in QKi also eases the constraint imposed by an existing liability
structure, for QKi is the source of the funds available to fulfill contracts
rising QKi thus diminishes the virtue of money as the source of insurance
as liquidity

-As the virtue of this insurance decreases, the desired cash

balance per unit of income and financial commitments also decreases, and
a further rise in the price of Q-yielding assets occurs.
-implies not only an increased ability to spend but it also augments the
ability to borrow
-Both a rise in QKi and a diminished virtue of liquidity tend to raise
the price of capital assets because the capitalization rate and the expected
returns tend to increase.
-Once debt structures are easy to bear,
then increased debt can be floated at favorable rates
-A rise in the price of capital assets relative to the price of current output
leads to increased consumption and investment(HOW AND WHY??)
-This moves the economy out of stagnation that follows a debt deflation.
-It may at first generate a period of relatively
tranquil expansion, but tranquility diminishes the value of the insurance
(liquidity) embodied in the dollar, so that a rise in the absolute and relative
prices of capital and financial assets that are valued mainly for income will
take place.
-Tranquility therefore leads to an increase in acceptable debt to
equity ratios even as it raises the value of inherited capital assets
Pg 205
-The analysis of investment begins with the determination of the prices of
capital assets.
-the quantity of money,
the value placed upon liquidity, and the income and liquidity characteristics
of the various capital and financial assets lead to the set of prices of
capital and financial assets
-The prices of capital and financial assets determine
the demand price for investment outputs of various kinds
-The demand prices for investment, however, do not determine the
pace of investment
-The existence of a market price for a capital asset and
a demand price for comparable investments does not necessarily imply that
there is an effective demand for investment; an effective demand for investment
takes financing
-There are three sources of such finance: cash and
financial assets on hand, internal funds (i.e., gross profits after taxes and
dividends), and external funds.
-Assuming that the per-unit supply price of investment rises after the
flow of investment exceeds some level, there is a maximum rate of
investment that will be produced at the price given by the demand price for
capital assets
-The stream of uncome from capital will be affected by the pace
of investment
-the aggregate funds available from internal
sources to finance gross investment fall short of the financing required by
gross investment
-In the decision to invest, the availability of
outside financing is a key element
-Planning an investment project involves two sets of interlocking decisions
on the part of the firm that is investing. One set deals with revenues
expected from using the capital asset in production and the cost of the

investment. The second set deals with financing the capital asset: a decision
to acquire capital assets is, basically, a decision to put out liabilities
-The costs(like interest rates) of financing the production of investment is a c
ost that
enters the supply price of output just like the costs of labor and purchased
-supply function of
investment, depends upon labor costs and short-term interest rates
-demand function for investment, is derived from the price of capital
assets, and the anticipated structure and conditions of financing
-the investment decision is based upon expected flows of internal and
external funds
-But the flows of internal funds to investing units depends
upon the performance of the economy during the period between the
decision to invest and the completion of the investment. Thus there is an uncert
-One concrete manifestation of the uncertainty that rules is found in
the willingness to lever or debt-finance positions in inherited capital assets,
financial assets, and newly produced capital assets
-Willingness to lever affects borrowers and lenders
-margins of safety required by both the borrowers and the lenders affect the
extent to which positions and investments are externally financed
-If the conventional liability structure for financing positions in
some capital assets changes so that more debt becomes acceptable, then the
firms that financed their positions by conforming to the prior conventions
acquire borrowing power: they can acquire cash by issuing more debt with
the same capital assets as before
-If the conventional debt-equity ratio does
not change, but the market valuation of the cash flow generated by capital
assets increases, then capital-asset-owning firms acquire borrowing power
-A stock market boom leads to a higher implicit market value of the underlying
capital assets of the economy; conversely, a fall in the stock market
lowers the implicit value.
-When debt is used to finance common-stock ownership, a rise in the price of the
stock will uncover an ability to borrow by the stockholders
-An initial rise in
the price of stocks can lead to a further rise in demand for stocks and leads to
building expected price; Symmetrically, a fall in stock market valuations will
decrease borrowing power and increase the burden of debt relative to asset value
-As the decline in the price of common stocks happen the acceptable leverage rat
io(deb/eq) falls
-borrowers and lenders both increase their required margins of safety
-The required margins of safety affect the acceptable financing plans
of investing units
-If recent experience is that outstanding debts
are easily serviced, then there will be a tendency to stretch debt ratios and vi
ce versa
-A history of success will tend to
diminish the margin of safety that business and bankers require and will
thus tend to be associated with increased investment; a history of failure
will do the opposite
-The price of capital assets is a demand price for investment output
-Given the labor force, wage rates, interest rates, and
the techniques embodied in the stock of capital assets for producing investment
output, there is a supply price of investment output

-Assuming that the existing stock of capital assets

and labor specialized to the production of plant and equipment sets limits
to the ability to produce investment, the supply curve of investment will
rise after output exceeds some norm
-the demand curve for investment that
is a horizontal line at the price of capital assets and a supply curve of invest
output that, after a threshold level, rises
-The above figure, however, has no place for financing: presumably
the amount of investment designated by the intersection will be ordered
independently of the financing arrangements.
-The investment producers will not undertake their activity unless there is
some guarantee that the final purchaser will be able to pay for the completed
investment good.
Pg 211
-Both borrowers and lenders want protection, and the
demand for protection by borrowers lowers the demand price for capital
assets and by lenders raises the supply price of investment output
-Once a project passes the test in making quasi resnts,the
decision whether or not to invest turns upon the conditions at which the
project can be financed
-three sources of financing can be distinguished:
a)cash and equivalent assets,
b)flow of gross profits after
dividends and taxes that accrue while the investment is being produced
c)external funds
-an excess of anticipated investment income over bond
interest payments is necessary if bonds are to finance investment projects
-The ratio of
external to internal financing can increase only if borrowers and lenders
expect the margin of safety to increase or hold that the prior margins of
safety were excessive.
-The belief that prior margins of safety were too great
(or too small) reflects the experience with liability structures; the margins
of safety relevant for decision change with experience.
-for a given flow of profits, the byer of capital assets can increase the margin
s of safety by lowering his demand price for capital assets. This reflects the b
orrowers risk.
-Internal cash flows can pay for some level of investment
-Once anticipated internal flows (Q)
are estimated, their relation to investment output can be represented as a
rectangular hyperbola
- Qn=Pi*Ii. With esitimated Qn and a known Pi, Ii can be estimated which is inte
rnal investment
-Investment in excess of Ii should be funded by external finance
-If financial assets are run down, then margins
of safety in the asset structure are reduced
-borrower's risk will increase as the weight of external or liquidity diminishin
g financing
-This borrower's risk is not reflected in any objective cost, but
it lowers the demand price of capital assets

Pg 216

-A deviation of quasi-rents affects price level of capital assets

-If actual quasi-rents are greater than
anticipated, then the excess of profits over expected profits will raise PK'
increasing the gap between PK and Pi
-This situation implies an increase in investment demand relative to
the availability of internal finance