In chapter 11, we described outcomes of investing either on the financial market or the capital goods market. We had also made the hypothesis that market forces would be at play to establish an equilibrium between those outcomes. Our aim in this chapter is to describe those forces. We begin with the case of a risk-free world in the sense that the existence of forward markets enables some investors to protect themselves against uncertainty (section 1). We then introduce uncertainty (section 2).

The case of risk-free transactions

We have considered four prices in the Fisher–Solow equation of interest: p(t) is the price of the capital good at time t; p(t + h) is the forward price for time t + h, decided upon at time t; q(t + h) is the forward rental rate of the capital good, to be received at time t + h; and i(t), the interest rate, is the price of loanable funds at time t. Until now, we have just supposed that an equilibrium would exist between these four prices, stemming from an equality between the available returns on the financial market and on the capital goods market. We will now describe the forces that come into play to establish this equilibrium.

Two types of forces should be distinguished. The first is arbitrage; we define arbitrage as the action of individuals who will earn benefits without committing their own resources. The second is investing, i.e. the action of agents who buy capital goods (or assets) with their own resources. In order to simplify the exposition, we suppose that the capital good may be borrowed, and also that we are able to sell it on a forward market.