The Two Market Principles (2)

The rate of interest must be such as will clear the market, that is, equalize supply and demand. That is, for every time interval, the additions to some individuals' incomes caused by borrowing or selling must balance the deductions from others caused by lending or buying.

The loans must be equivalent in present worth to repayments, or, more generally, the additions to any individual's income, brought about by borrowing or selling, in some time intervals must be equivalent in present worth to the deductions from his income in other time intervals brought about by lending or buying.

Thus we see that the rate of interest is determined by two principles of investment opportunity as well as by two principles of impatience and by the two self-evident market principles.

More briefly stated, the rate of interest is determined so as (1) to make the most of opportunities to invest, (2) to make the best adjustment for impatience and (3) to clear the market and repay debts.

In short, the theory is thus one of investment opportunity and human impatience, as well as exchange.

But while we have reached the two chief theoretical foundations of our subject, we are still, of course, far from the real world. The real world is vastly more complex than the imaginary world described in this chapter. In particular, we still need to take account of risk. This we shall do in the third approximation.