A Contribution to Theory of Factor Income Distribution, Cambridge Capital Controversy and Equity Premium Puzzle

Abstract

Under very general conditions, we construct a micro-macro model for closed economy with a large number of heterogeneous agents. By introducing both financial capital (i.e. valued capital—equities of firms) and physical capital (i.e. capital goods), our framework gives a logically consistent, complete factor income distribution theory with micro-foundation. The model shows factor incomes obey different distribution rules at the micro and macro levels, while marginal distribution theory and no-arbitrage princi-ple are unified into a common framework. Our efforts solve the main problems of Cambridge capital controversy, and reasonably explain the equity premium puzzle. Strong empirical evidences support our results.

Keywords: profit rate, capital controversy, equity premium puzzle

JEL Classification: D33, E25, G12