Assume that the economy is in equilibrium with the pure rate of interest at 7 percent per year and an investment of funds in a particular project would return 11 percent per year.Frank Knight would argue that most of the 4 percent differential is

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Frank Knight would argue that the 4 percent differential is a premium for the risk inherent in this project. Knight believed that uncertainty and risk were inherent in investing and that the return on investment reflected the willingness of investors to bear that risk. A return of 11 percent on investment indicates that the market perceives this project to be riskier than the economy as a whole with a pure rate of interest at 7 percent. Thus, investors demand a higher return to compensate them for taking on that risk.

Assume That the Economy Is in Equilibrium with the Pure