The Concept of Economic Efficiency 33 



were fixed. In the case of some resources and in a purely physical 

 sense, this is doubtless true. In an economic sense, however, this 

 will almost never be so. In progressive economies, total income 

 and output have risen almost continuously through time. Yet 

 growth in output requires either additional productive resources 

 or advances in the state of the industrial arts. Both have occurred, 

 and both have been accompanied by additional investment. In 

 short, through development and with the employment of capital, 

 productive resources of most kinds are being increased. For under- 

 standing of our competitive model, this raises several questions: 

 What is the origin of capital? What determines the amount for 

 use in new investment? And, given the quantity of investment 

 funds, what represents an efficient allocation among investment 

 alternatives? 



The term "capital" has been given many meanings; we must 

 first make clear the sense in which it is used here. Capital is simply 

 the stock of goods produced in the past and available to assist in 

 the present and future production of additional goods. Of the 

 total national output produced in any period, a part is consumed 

 and the remainder is added to the community's stock of capital. 

 The change in capital stock over any period is called the net invest- 

 ment (positive or negative) in that period. 



Since the total output of which an economy is capable depends 

 among other things on its capital stock, the rate of investment 

 helps to determine the rate of output. The amount of investment 

 depends on the willingness of consumers, through savings, to 

 release part of the output for investment purposes; thus the rate 

 of growth in output depends on consumers' willingness to save. 



Let us begin our examination of the competitive capital market 

 by analyzing the supply side, that is, the willingness of consumers 

 to save. In Figure 7, we assume that the consumer has a certain 

 income, OY, and that he is free to save as much as he chooses at 

 an interest rate of i per cent a year. The slope of the line XY is 

 equal to the interest rate and indicates how large a future stream 

 of income in the form of interest payments the consumer will 

 receive per dollar saved. Whether a consumer will desire to save 

 much or little depends on his preferences, as reflected by the indif- 

 ference curves. He will be indifferent at all points on the same 

 curve. At point a he will enjoy a high rate of current consumption, 

 but will hold a relatively small stock of wealth and receive but 

 little interest income. At point b his present consumption will be 



