In a hypothetical free market without risk, we found that the rate of return to investors (also called capitalists) approaches the market interest rate (p. 4.8:26). When risk is present, that conclusion must be amended as follows:
Investors tend to earn:
  • the market interest rate; plus
  • a premium just sufficient to compensate them for the marginal disutility of the risk incurred by their investment.
Precisely because risk is present, the investor's rate of return in particular cases may either exceed or fall short of the rate indicated by the box.

The return on investment, of course, equals the difference between the payment received for the consumers' good and the total expenditures on the factors of production. Consequently, in a market with risk each factor earns somewhat less than its DMVP. The difference, totaled across the various factors, is the risk premium.   Next page

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