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Volatility and Growth$
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Philippe Aghion and Abhijit Banerjee

Print publication date: 2005

Print ISBN-13: 9780199248612

Published to Oxford Scholarship Online: January 2007

DOI: 10.1093/acprof:oso/9780199248612.001.0001

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Modeling Credit Markets

Modeling Credit Markets

(p.5) 0 Modeling Credit Markets
Volatility and Growth

Phillippe Aghion (Contributor Webpage)

Abhijit Banerjee (Contributor Webpage)

Oxford University Press

One of the core assumptions of the neoclassical model is that there is a single market interest rate and every firm invests to the point where their marginal product is equal to this rate. There is a large body of research showing that this neoclassical postulate often does a very poor job of describing reality. It is shown that there seems to be clear evidence that the typical firm, at least in the developing world, has a marginal product which is substantially above the market interest rate. This suggests that the firm cannot borrow as much as it wants at the going market rate. In other words, the supply curve of capital to the firm must be upward sloping, or even vertical (a hard limit on how much the firm can borrow). A simple model is sketched that explains why lenders impose limits on how much firms can borrow.

Keywords:   neoclassical model, interest rate, capital, lenders, developing world

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