Stating major assumptions in the Kaldor model of disbribution, establish that share of profits in national income depends on the ratio of investment to total output.

Major Assumptions of the Kaldor Model

The Kaldor model rests on several key assumptions:

• Constant Returns to Scale: The production function exhibits constant returns to scale, meaning that a proportional increase in inputs leads to a proportional increase in output.
• Fixed Capital-Output Ratio (v): A crucial assumption is that the capital-output ratio (v) remains relatively stable. This implies a consistent relationship between the amount of capital employed and the level of output produced.
• Constant Savings Rate (s): The propensity to save out of income is assumed to be constant across all income classes.
• Wage-Profit Ratio (w): The ratio of wages to profits is assumed to be determined by institutional factors and is relatively stable.
• Closed Economy: The model typically assumes a closed economy, meaning there are no international trade flows.

The Relationship Between Investment, Output, and Profit Share

Kaldor’s model establishes a direct link between the share of profits and the investment-output ratio. The core logic can be explained as follows:

1. Investment and Capital Accumulation: Investment increases the capital stock.
2. Capital-Output Ratio: Given the fixed capital-output ratio (v), an increase in the capital stock leads to a proportional increase in output.
3. Savings and Investment Equality: In equilibrium, total savings must equal total investment.
4. Profit Share Determination: The share of profits (π) is determined by the following equation:

   π = s * v

   Where:

   • π = Share of profits in national income
   • s = Aggregate savings rate
   • v = Capital-output ratio (Investment/Output)

   This equation demonstrates that the share of profits is directly proportional to both the aggregate savings rate and the capital-output ratio. A higher investment-output ratio (v) implies a greater proportion of income is being invested, leading to a higher share of profits. Conversely, a lower investment-output ratio results in a lower profit share.

Mechanism Explained

The model suggests that if investment increases relative to output (higher 'v'), the demand for capital rises. This increased demand pushes up the rate of return on capital, leading to a larger share of income accruing to capitalists as profits. Conversely, if investment falls relative to output (lower 'v'), the demand for capital decreases, reducing the rate of return on capital and shrinking the profit share. The wage-profit ratio remains relatively stable due to institutional factors like labor union bargaining power and minimum wage laws.

Limitations

While insightful, the Kaldor model has limitations. The assumption of a fixed capital-output ratio is often criticized as unrealistic in the long run due to technological progress. Furthermore, the model's focus on macroeconomic variables may overlook microeconomic factors influencing income distribution. The closed economy assumption also limits its applicability to modern, open economies.