Fifteen years after the Global Financial Crisis: Recessions and Business Cycles in the History of Economic Thought

Austrian capital theory in the neoclassical veil

Potuzak Pavel, Prague University of Economics and Business

The Austrian theory of capital, initially formulated by Menger (1871) and Böhm-Bawerk (1891), and later refined by Hayek (1941), argues that longer (or roundabout) production methods yield higher productivity compared to shorter methods. Contemporary Austrian scholars generally refrain from employing mathematical models to explain Austrian capital theory. In contrast, Hicks's (1973) neo-Austrian approach seems too complex to serve as a central part of mainstream textbooks. This paper aims to explain the Austrian theory of capital within the standard textbook model using the production function, the utility function, and the intertemporal budget constraint. This paper presents a simple model that integrates the Austrian perspective on capital with the neoclassical framework of the economy. The two-period model shows that present labour can be allocated not only to produce output in the present period but also to a lengthier and more productive process that generates output in the future period. In addition, the longer process necessitates labour in the future period for its completion. The equilibrium conditions are derived through conventional optimization methods. It is explored how the equilibrium real interest rate may be influenced by factors such as time preference, the productivity of shorter methods, and the productivity of longer methods.

Area: Eshet Conference

Keywords: Austrian capital theory, production function, optimization

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