Cambridge capital controversy
The Cambridge capital controversy – sometimes called "the capital controversy" or "the two Cambridges debate" – refers to a theoretical and mathematical debate during the 1960s among economists concerning the nature and role of capital goods and the critique of the dominant neoclassical vision of aggregate production and distribution. The name arises because of the location of the principals involved in the controversy: the debate was largely between economists such as Joan Robinson and Piero Sraffa at the University of Cambridge in England and economists such as Paul Samuelson and Robert Solow at the Massachusetts Institute of Technology, in Cambridge, Massachusetts.
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- Keynes's answer was that the rate of interest was determined in the financial markets, and there is no reason why it should necessarily gravitate to the requisite level. It was not a very convincing answer. This was the weakness Hicks would exploit. The demand function for investment (which Keynes called the marginal efficiency of capital schedule) was the Trojan horse that allowed the forces of his enemies to attack the very heart of Keynes's case for an under-employment equilibrium and hence for active government.
It was one of Keynes's closest collaborators who solved the dilemma. From 1936 on, Joan Robinson had argued that if Keynes was right about the determination of employment, then orthodox theory must be wrong about the determination of prices. In the mid-1960s she at last found a way of sustaining her argument.
- The high theory debates that she and others conducted with the more orthodox theorists of MIT reached an agreed conclusion when Paul Samuelson was forced to concede that there was no logically consistent way to construct a demand function for capital outside the artificial confines of a one-commodity world (see the symposium on paradoxes in capital theory, Quarterly Journal of Economics, 1966). This, in turn, means that it is not possible to formulate a logically consistent theory of the long-run normal rate of interest; hence no consistent theory of long-run prices or of output and employment is possible either. Building so-called Keynesian models on the basis of market failure no longer makes sense--there cannot be a short-run deviation from a long-run equilibrium that is not there in the first place! In one stroke the critical task in which Keynes had failed was accomplished, and the marginal efficiency of capital schedule was swept away too. What was left was the part of his theory that Keynes himself had regarded as his truly original contribution--the principle of effective demand.