There must be (1) an increasing marginal rate of substitution between outputs; (2) a diminishing marginal rate of substitution between inputs; (3) a diminishing marginal rate of transformation of an input into an output.The author points out that these conditions have the same form as those found for the static equilibrium case. In addition, there is an analogous condition to the static one that requires a positive surplus; in the dynamic case, the condition is that "the present value of the stream of surpluses must be positive."
The latter part of this section addresses the conditions needed to ensure the stability of equilibrium under perfect competition. In the static case, these involved postulating the existence of limitations on increasing the capacity of certain factors of production, such that overall returns were diminishing. The author then asks what the situation looks like in the dynamic case. His answer to this question covers two cases
(1) where the entrepreneur, at the date in question, has an already established business, (2) where he is a potential entrepreneur considering whether to set up a business, and, if so, what sort of a business to set up.In the first case, the author concludes that the "fixity" (or fixed nature) of the resources required for setting up the business is sufficient for providing the necessary diminishing returns. In the case of the new firm, the author identifies both the difficulties of management and control in the absence of "standing rules" for running the business, as well as the element of risk.
Overall, the author concludes that "we need have rather less compunction" in assuming perfect competition in the dynamic case than in the static case. This is because "The elements which limit the size of firms in practice are very largely dynamic elements."
