The theoretical basis

Recent debates on capital theory have focused on the notion of capital as a factor of production, which along with labor, can be used to explain the distribution of income in capitalist economy. Though the intricate point and counterpoint of the controversy often obscure this simple fact, it has become increasingly clear that what is at stake in the current debate is in essence the same issue with which the classical economists, particularly Ricardo, grappled – that of the division of income between wages and profits. The argument thus rages around descriptive economic theory, whose aim it is to represent the workings of a competitive capitalist economy. In a sense this is a return to relevance, since much of modern mathematical economics has studiously concerned itself, not with descriptive, but instead with normative theory, such as the study of optimal and efficient growth paths, etc., (Lancaster, 1968, pp. 9–10).

In neoclassical theory, the model of pure exchange occupies a central position, for it illustrates simply and elegantly the fundamental truths of the paradigm, truths which any more complex representations may modify but certainly cannot undermine. Thus, in the model of pure exchange, trading begins with selfish individuals each having an arbitrarily determined initial endowment of goods, and proceeds to a final state in which no one individual can improve his or her basket of commodities without making someone else worse off. Such a situation is known as a pareto-optimal allocation, and it implies a set of final exchange ratios between commodities – that is, a set of equilibrium relative prices.