The Concept of Economic Efficiency 47 



DEPARTURES FROM COMPETITIVE ASSUMPTIONS 

 IN THE CAPITAL MARKET 



Two assumptions regarding the efficiency of the supply and 

 allocation of capital in the competitive model are subject to quali- 

 fication. In the discussion of the supply of investment funds, it 

 was assumed that savers would be willing to lend an amount iden- 

 tical to what they would save at any rate of interest. Furthermore, 

 it was assumed that the enterprise would avail itself of an unre- 

 stricted access to the capital market at the prevailing market rate 

 so long as its anticipated returns exceeded the market rate of 

 interest. 



From an individual saver's point of view, investing or lending 

 funds involves the risk of failing to recoup his investment or have 

 his loan repaid. Furthermore, in an uncertain world, the indi- 

 vidual sacrifices security when he surrenders the liquidity which 

 cash or bank balances represent. The risk of losses, and the value 

 of remaining liquid when one's personal fortunes must remain 

 uncertain, require a premium to induce an individual to part with 

 his savings. Consequently, at any rate of interest, a smaller amount 

 of investment funds than savings would be provided. The market 

 rate of interest will depart from the rate inferred from the com- 

 petitive model by an amount equal to the risk premium required. 



The profit-maximizing behavior of the enterprise in the competi- 

 tive model also assumed that investment would be carried to the 

 point where the rate of return at the margin equaled the interest 

 rate. This was a necessary condition for maximum economic 

 efficiency. In actual practice, however, the uncertainty of realizing 

 anticipations with respect to an investment opportunity means that 

 the future income stream is discounted significantly. Enterprises 

 do not knowingly invest in activities in which the prospective 

 returns at the margin only equal the borrowing cost. Expectations 

 are not always realized and returns may fall short of the ex ante 

 expectation. This is evidence of "imperfect foresight," a qualifica- 

 tion of the competitive model rather than evidence that investment 

 is carried to the margin. 



Enterprises, thus, may be reluctant to avail themselves of invest- 

 ment funds even though prospective returns exceed borrowing 

 costs. To elaborate this point: the higher the ratio of borrowed 



