The discount theory of interest which we have just examined emphasizes the supply side of the problem of interest. It calls attention to the strength of the forces which are conspiring to defer the consumption of present income to a future date and thus creating capital. The marginal productivity theory, which will be treated next, places the emphasis on the demand side of the problem. It points to the strength of the forces which call for an increase of capital. The discount theory does not entirely neglect the demand side nor does the marginal productivity theory fail to account for supply. Still the first is predominantly a supply theory of interest and the second is a demand theory. They approach the problem from different sides and the explanation given by both theories together furnishes a more complete view than that which one gets from either theory alone.

In the explanation of interest, as in the explanation of the other shares in distribution, the marginal productivity theory is intimately associated with the law of diminishing returns. Four machines of an advanced type installed in a factory may be effective in producing a considerable increase in output as compared with old methods. The adding of a fifth machine may increase not only the total output but also the output per machine, while the addition of a sixth machine, although resulting in an addition to the total output, may mean a diminution of product per machine. Nevertheless, it will be useful to continue to add machines as long as each additional machine contributes to the total product a greater amount than the cost of the machine. If the employer hires the machine from a capitalist, he will have to pay a gross interest which will include an amount for depreciation sufficient to pay for wear and tear on the machine and a net interest for the use of the machine. If this charge which the capitalist makes is less than the amount added by the machine to the total product, the employer will consider the situation a very favorable one and he will hire more machines of this kind. He will continue to do so until the point is reached where the charge made for the use of the machine is just equal to the product added by the last machine secured.

Capitalists who have machines to furnish to employers will bid against one another in their efforts to place the machines, and will thus bring down the interest; that is, the hire of the machines, to the point where it just pays to supply machines. On the other hand, the employers will compete against one another to secure the capital; namely, the machines, and hence will bid up interest to the point where the added product of an additional machine just equals what they must pay for the use of the machine. Thus more machines will continue to be employed and the product of the marginal machine will be continually reduced until it does not pay to make any more machines of this kind. At this point the interest paid for the use of a machine will just equal the marginal product of the machine after a proper amount has been provided for depreciation.