§1. Preference for Present over Future Income

IN the preceding chapter we mentioned some pitfalls in the explanation of interest. We are now ready to consider more searchingly the fundamental causes which determine the rate of interest. We shall find a place for each of the partial truths contained in the inadequate theories.

Many people think of interest as dependent directly on capital. As already suggested, it will help the reader to proceed in the following analysis if he will try to forget capital and instead think exclusively of income. Capital wealth is merely the means to the end called income, while capital value (which is the sense in which the term capital is ordinarily used by interest theorists) is merely the capitalization of expected income.

The theory of interest bears a close resemblance to the theory of prices, of which, in fact, it is a special aspect. The rate of interest expresses a price in the exchange between present and future goods. Just as, in the ordinary theory of prices, the ratio of exchange of any two articles is based, in part, on a psychological or subjective element—their comparative marginal desirability—so, in the theory of interest, the rate of interest, or the premium on the exchange between present and future goods, is based, in part, on a subjective element, a derivative of marginal Edition: current; Page: [62] desirability; namely, the marginal preference for present over future goods. This preference has been called time preference, or human impatience. The chief other part is an objective element, investment opportunity. It is the impatience factor which we shall now discuss, leaving the investment opportunity factor for discussion in later chapters.

Time preference, or impatience, plays a central rôle in the theory of interest. It is essentially what Rae calls the "effective desire for accumulation," and what Böhm-Bawerk calls the "perspective undervaluation of the future." It is the (percentage) excess of the present marginal want for29 one more unit of present goods over the present marginal want for one more unit of future goods. Thus the rate of time preference, or degree of impatience, for present over future goods of like kind is readily derived from the marginal desirabilities of, or wants for, those present and future goods respectively.30

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