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The Price of Capital, Factor Substitutability and Corporate Profits

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Abstract

Technical progress has contributed to a steady decline in the relative price of new capital goods and at the same time facilitated the substitutability between physical capital and labor in output production. This paper studies the quantitative implications that these two changes have for the level and the variability of firm' profits, the capital-to-labor ratio, and also for labor market outcomes when profits arise from rents paid to quasi-fixed factors of production. We embed a CES production function into a model of capital accumulation and competitive search in the labor market, allowing firms to increase their size by hiring multiple workers. We use our model to disentangle the effects of the decline in the relative price of capital and increased factor substitutability. Our analysis identifies each of these two changes as important drivers of the empirically observed rise in the capital- to-labor ratio and in the level and variability of firms' profits. Their overall effect on wages, employment, and the labor share of income is inconclusive, since their respective impact on each of these variables goes in the opposite direction.

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  • Philipp Hergovich & Monika Merz, 2018. "The Price of Capital, Factor Substitutability and Corporate Profits," Vienna Economics Papers vie1801, University of Vienna, Department of Economics.
    • Handle: RePEc:vie:viennp:vie1801
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    Cited by:

    1. Matteo G. Richiardi & Luis Valenzuela, 2024. "Firm heterogeneity and the aggregate labour share," LABOUR, CEIS, vol. 38(1), pages 66-101, March.
    2. Jakob Grazzini & Lorenza Rossi, 2020. "New Firms, Capital Intensity and the Labor Share: New Theoretical and Empirical Insights," CESifo Working Paper Series 8255, CESifo.
    3. Antonio Estache & Beni Kouevi Gath, 2019. "Corporate Income Taxes and (Un-)Employment in the OECD," Working Papers ECARES 2019-11, ULB -- Universite Libre de Bruxelles.

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    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search

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