IRVING FISHER, THE THEORY OF INTEREST, AS DETERMINED …

1 11/02/2005 02:31 PMFisher_0219 Page 1 of 183 ONLINE LIBRARY OF LIBERTY Liberty Fund, Inc. 2005 fisher , THE THEORY OF INTEREST, AS DETERMINED BY IMPATIENCE TO SPEND income AND OPPORTUNITY TOINVEST IT (1930)URL of this E-Book: of original HTML file: ABOUT THE AUTHORI rving fisher was one of America s greatest mathematical economists and one of the clearest economicswriters of all time. He had the intellect to use mathematics in virtually all his theories and the good sense tointroduce it only after he had clearly explained the central principles in words. Although he damaged hisreputation by insisting throughout the Great Depression that recovery was imminent, contemporary economicmodels of interest and capital are based on Fisherian principles. Similarly, monetarism is founded on fisher sprinciples of money and prices. ABOUT THE BOOKF isher was one of America s greatest mathematical economists.

2 This book is still used a textbook and is anoutstanding example of clearly written economic THEORY . THE EDITION USEDThe THEORY of Interest, as DETERMINED by Impatience to Spend income and Opportunity to Invest it (NewYork: Macmillan, 1930). COPYRIGHT INFORMATIONThe text of this edition is in the public domain. FAIR USE STATEMENTThis material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in theCopyright Information section above, this material may be used freely for educational and academic may not be used in any way for profit. _____TABLE OF CONTENTSFIRST SUMMARYPART I. INTRODUCTIONPART II. THE THEORY IN WORDSPART III. THE THEORY IN MATHEMATICSPART IV. FURTHER DISCUSSIONSECOND SUMMARYPART I. INTRODUCTIONI. income AND CAPITALFOOTNOTES FOR CHAPTER III. MONEY INTEREST AND REAL INTERESTFOOTNOTES FOR CHAPTER IIIII.

3 SOME COMMON PITFALLSFOOTNOTES FOR CHAPTER IIIPART II. THE THEORY IN WORDSIV. TIME PREFERENCE (HUMAN IMPATIENCE)FOOTNOTES FOR CHAPTER IVV. FIRST APPROXIMATION TO THE THEORY OF INTEREST (ASSUMING EACH PERSON'S income STREAM FOREKNOWN AND UNCHANGEABLE EXCEPT BY LOANS)FOOTNOTES FOR CHAPTER VVI. SECOND APPROXIMATION TO THE THEORY OF INTEREST (ASSUMING income MODIFIABLE (1) BY LOANS AND (2) BY OTHER MEANS)FOOTNOTES FOR CHAPTER VIVII. THE INVESTMENT OPPORTUNITY PRINCIPLESFOOTNOTES FOR CHAPTER VIIVIII. DISCUSSION OF THE SECOND APPROXIMATION11/02/2005 02:31 PMFisher_0219 Page 2 of 183 FOR CHAPTER VIIIIX. THIRD APPROXIMATION TO THE THEORY OF INTEREST (ASSUMING income UNCERTAIN)FOOTNOTES FOR CHAPTER IXPART III. THE THEORY IN MATHEMATICSX. FIRST APPROXIMATION IN GEOMETRIC TERMSFOOTNOTES FOR CHAPTER XXI. SECOND APPROXIMATION IN GEOMETRIC TERMSFOOTNOTES FOR CHAPTER XIXII.

4 FIRST APPROXIMATION IN TERMS OF FORMULASFOOTNOTES FOR CHAPTER XIIXIII. SECOND APPROXIMATION IN TERMS OF FORMULASFOOTNOTES FOR CHAPTER XIIIXIV. THE THIRD APPROXIMATION UNADAPTED TO MATHEMATICAL FORMULATIONFOOTNOTES FOR CHAPTER XIVPART IV. FURTHER DISCUSSIONXV. THE PLACE OF INTEREST IN ECONOMICSFOOTNOTES FOR CHAPTER XVXVI. RELATION OF DISCOVERY AND INVENTION TO INTEREST RATESFOOTNOTES FOR CHAPTER XVIXVII. PERSONAL AND BUSINESS LOANSXVIII. SOME ILLUSTRATIVE FACTSFOOTNOTES FOR CHAPTER XVIIIXIX. THE RELATION OF INTEREST TO MONEY AND PRICESFOOTNOTES FOR CHAPTER XIXXX. OBJECTIONS CONSIDEREDFOOTNOTES FOR CHAPTER XXXXI. SUMMARYFOOTNOTES FOR CHAPTER XXIAPPENDICESFOOTNOTES FOR APPENDIX TO CHAPTER IFOOTNOTES FOR APPENDIX TO CHAPTER XIIFOOTNOTES FOR APPENDIX TO CHAPTER XIIIFOOTNOTES FOR APPENDIX TO CHAPTER XXBIBLIOGRAPHYANALYTICAL TABLE OF CONTENTSCHAPTER IINCOME AND CAPITAL 1.

5 SUBJECTIVE, OR ENJOYMENT, income 2. OBJECTIVE, OR REAL, income (OUR "LIVING") 3. COST OF LIVING, A MEASURE OF REAL income 4. COST OF AN ARTICLE VS. COST OF ITS USE 5. MEASURING AT THE DOMESTIC THRESHOLD 6. MONEY income 7. CAPITAL VALUE 8. THE RATE OFINTEREST 9. DISCOUNTING IS FUNDAMENTAL 10. COSTS, OR NEGATIVE income 11. THE DISCOUNT PRINCIPLE APPLIED 12. DOUBLE ENTRY BOOKKEEPING 13. SIMPLICITY UNDERLYING COMPLICATIONS 14. CAPITAL GAIN NOT income 15. CAPITAL income RELATIONS 16. APPLICATION TO THIS BOOK 17. CONFUSIONS TO BE AVOIDED 18. A WORKING CONCEPT OF THE RATE OF INTERESTFOOTNOTES FOR CHAPTER ICHAPTER IIMONEY INTEREST AND REAL INTEREST 1. INTRODUCTION 2. ASSUMING FORESIGHT 3. LIMITATIONS OF THEORY11/02/2005 02:31 PMFisher_0219 Page 3 of 183 4. REAL AND MONEY INTERESTFOOTNOTES FOR CHAPTER IICHAPTER IIISOME COMMON PITFALLS 1.

6 INTRODUCTION 2. THE EXPLOITATION EXPLANATION OF INTEREST 3. INTEREST-TAKING SURVIVES ALL OPPOSITION 4. NA VE PRODUCTIVITY EXPLANATIONS 5. TWO OTHER PITFALLSFOOTNOTES FOR CHAPTER IIICHAPTER IVTIME PREFERENCE (HUMAN IMPATIENCE) 1. PREFERENCE FOR PRESENT OVER FUTURE income 2. REDUCTION TO ENJOYMENT income 3. IMPATIENCE DEPENDS ON income 4. INTEREST AND PRICE THEORY 5. SPECIFICATIONS OF income 6. THE INFLUENCE OF MERE SIZE 7. THE INFLUENCE OF TIME SHAPE 8. THE INFLUENCE OF RISK 9. THE PERSONAL FACTOR 10. THE PERSONAL FACTOR SUMMARIZED 11. income RATHER THAN CAPITAL IN THE LEADING R LE 12. IMPATIENCE SCHEDULESFOOTNOTES FOR CHAPTER IVCHAPTER VFIRST APPROXIMATION TO THE THEORY OF INTERESTASSUMING EACH PERSON'S income STREAM FOREKNOWN AND UNCHANGEABLE EXCEPT BY LOANS 1. HYPOTHESES OF FIRST APPROXIMATION 2. income PRESCRIBED 3.

7 EQUALIZATION OF IMPATIENCE 4. ALTERING income BY LOANS 5. ALTERING income BY SALE 6. INTEREST INERADICABLE 7. "MARGINAL" PRINCIPLE IS "MAXIMUM" PRINCIPLE 8. MARKET EQUILIBRIUM 9. FOUR PRINCIPLESFOOTNOTES FOR CHAPTER VCHAPTER VISECOND APPROXIMATION TO THE THEORY OF INTERESTASSUMING income MODIFIABLE (1) BY LOANS AND (2) BY OTHER MEANS 1. THE NEW HYPOTHESES 2. OPTIONAL income STREAMS 3. THE TWO KINDS OF CHOICE 4. OPPORTUNITY TO INVEST BY CHANGE OF USE OF CAPITAL 5. THE REASONING NOT "CIRCULAR" 6. SUMMARYFOOTNOTES FOR CHAPTER VICHAPTER VIITHE INVESTMENT OPPORTUNITY PRINCIPLES 1. ELIGIBLE AND INELIGIBLE OPTIONS 2. THE METHOD OF COMPARATIVE ADVANTAGE 3. THE CONCEPT OF RATE OF RETURN OVER COST 4. THE PRINCIPLE OF RETURN OVER COST 5. MARGINAL RATE OF RETURN OVER COST 6. THE ILLUSTRATION OF CUTTING A FOREST 7. OTHER SIMILAR ILLUSTRATIONS 8.

8 THE CASE OF PERPETUAL RETURNS 9. THE GENERAL CASE 10. RANGE OF CHOICE DEPENDS ON INTEREST RATE 11. THE INVESTMENT OPPORTUNITY PRINCIPLES SUMMARIZED 12. INTERRELATION OF HUMAN IMPATIENCE AND INVESTMENT OPPORTUNITY11/02/2005 02:31 PMFisher_0219 Page 4 of 183 FOR CHAPTER VIICHAPTER VIIIDISCUSSION OF THE SECOND APPROXIMATION 1. OPPORTUNITY REDUCED TO LOWEST TERMS 2. INVESTMENT OPPORTUNITY ESSENTIAL 3. OPTIONS DIFFERING IN TIME SHAPE ONLY 4. THE IMAGINARY "HARD-TACK" ILLUSTRATION 5. THE IMAGINARY "FIGS" EXAMPLE 6. THE IMAGINARY "SHEEP" EXAMPLE 7. OPPORTUNITIES AS TO REPAIRS, RENEWALS, BETTERMENTS 8. OPPORTUNITY TO CHANGE THE APPLICATION OF LABOR 9. FLUCTUATIONS IN INTEREST RATES SELF-CORRECTIVE 10. WIDE OPPORTUNITIES STABILIZE INTERESTFOOTNOTES FOR CHAPTER VIIICHAPTER IXTHIRD APPROXIMATION TO THE THEORY OF INTERESTASSUMING income UNCERTAIN 1.

9 MORE THAN ONE RATE OF INTEREST 2. RELATIONS BETWEEN THE VARIOUS RATES 3. LIMITATIONS ON LOANS 4. RISK AND SMALL LOANS 5. SALABILITY AS A SAFEGUARD 6. GENERAL income RISKS 7. SECURITIES CLASSIFIED AS TO RISK 8. EFFECT OF RISK ON THE SIX PRINCIPLES 9. SUMMARY OF THE THREE APPROXIMATIONS (NUMBERED 1, 2, 3)FOOTNOTES FOR CHAPTER IXCHAPTER XFIRST APPROXIMATION IN GEOMETRIC TERMS 1. INTRODUCTION 2. THE MAP OF THIS YEAR'S AND NEXT YEAR'S income 3. THE MARKET LINE 4. THE WILLINGNESS LINE 5. THE TWO LINES COMPARED 6. THE WHOLE FAMILY OF MARKET LINES 7. MANY FAMILIES OF WILLINGNESS LINES 8. A TYPICAL FAMILY OF WILLINGNESS LINES 9. TIME PREFERENCE MAY BE NEGATIVE 10. THE PERSONAL AND IMPERSONAL INFLUENCES ON IMPATIENCE 11. DECIDING WHETHER TO BORROW OR LEND 12. INTEREST FIXED FOR AN INDIVIDUAL 13. HOW AN INDIVIDUAL ADJUSTS HIS income POSITION TO THE MARKET 14.

10 MARKET EQUILIBRIUM 15. THE FOUR PRINCIPLES CHARTED 16. THE GEOMETRIC METHOD 17. RELATION TO SUPPLY AND DEMANDFOOTNOTES FOR CHAPTER XCHAPTER XISECOND APPROXIMATION IN GEOMETRIC TERMS 1. INTRODUCTION 2. THE INVESTMENT OPPORTUNITY LINE 3. THE INDIVIDUAL'S ADJUSTMENT WITHOUT LOANS 4. INDIVIDUAL ADJUSTMENT WITH LOANS 5. THE DOUBLE ADJUSTMENT DISCUSSED 6. MARKET EQUILIBRIUM 7. THE NATURE OF THE OPPORTUNITY LINE DISCUSSED 8. INVESTMENT OPPORTUNITY AND IMPATIENCE 9. CAN INTEREST DISAPPEAR? 10. DOES INTEREST STIMULATE SAVING? 11. RELATION TO SUPPLY AND DEMAND CURVESFOOTNOTES FOR CHAPTER XICHAPTER XIIFIRST APPROXIMATION IN TERMS OF FORMULAS11/02/2005 02:31 PMFisher_0219 Page 5 of 183 1. CASE OF TWO YEARS AND THREE INDIVIDUALS 2. IMPATIENCE PRINCIPLE A. (THREE EQUATIONS) 3. IMPATIENCE PRINCIPLE B. (THREE EQUATIONS) 4. MARKET PRINCIPLE A.