The Price of Capital, Factor Substitutability, and Corporate Profits

Monika Merz and Philipp Hergovich

No 13168, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: The capital-to-labor ratio has steadily risen in the U.S. and elsewhere during the post-WWII period. Since the 1970s this rise has been accompanied by a rise in the level and variability of corporate profits whereas the labor share of income has declined. In this paper we ask whether these trends are related in that they can be explained by a common determinant such as the observed decline in the relative price of new capital goods, or the change in production technology towards increased substitutability between capital and labor. We use a dynamic stochastic equilibrium model of competitive search in the labor market augmented by a CES production function that allows firms to substitute between capital and labor at varying degrees. By assumption, firms can adjust capital more easily than labor. Profits arise from rents paid to quasi-fixed factors of production. We find that the declining relative price of capital and the increase in factor substitutability each causes the capital-to-labor ratio and corporate profits to rise, but only increased factor substitutability generates the observed decrease in the labor share of income and increases the relative variability of profits.

Keywords: Factor substitutability; Quasi-fixed production factor; Competitive search; Profits (search for similar items in EconPapers)
JEL-codes: E24 G32 J64 (search for similar items in EconPapers)
Date: 2018-09
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Working Paper: The Price of Capital, Factor Substitutability, and Corporate Profits (2018)
Working Paper: The Price of Capital, Factor Substitutability and Corporate Profits (2018)
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