CHAPTER 15: INTEREST RATES AND THE CAPITAL MARKET
A BRIEF OVERVIEW OF THE CAPITAL MARKET:
- Firms require physical capital to produce
- Purchases of new capital equipment are investments
- Also require working capital, which are funds used to acquire physical capital
(materials, labour, etc)
- Firms finance their activities in one of four ways:
a. Retained Earnings
b. Borrow from banks and other financial intermediaries
c. Issuing bonds and thereby borrow directly from lenders
d. Sell stocks for additional capital
- Household saving determines total supply of financial capital
- The illustration below showcases the interaction of firms and households:
- When economists speak of the demand and supply for labour, they are referring
to the flow of labour services
- Example → firm hires the services of a worker for a week, after which the
firm and worker go separate ways
- When a firm considers its demand for physical capital, it is considering
purchasing a new piece of equipment and thereby adding to its stock of capital.
This piece of equipment will have many useful lives
, PRESENT VALUE:
- Present Value → the most that someone would be prepared to pay to get a
specific amount in the future
PRESENT VALUE FORMULA:
- PV = FV/(1 + r)^n
THE PRESENT VALUE OF A STREAM OF FUTURE SUMS:
- To consider the present value of payments that continues for many periods, you
must take into account each period individually
- Example → One new lathe may generate a marginal revenue product equal
to $200 one year from now, $180 two years from now, and $210 three
years from now before it wears out and caesar to generate any further
benefits
- Solution:
THE DEMAND FOR CAPITAL:
- A firm’s demand for financial capital comes from its demand for physical capital
- Economists assume that the amount of physical capital the firm chooses to use
comes from its objective of maximizing profit
THE FIRM’S DEMAND FOR CAPITAL:
- An individual firm faces a given interest rate and a given purchase price of capital
goods
- The firm can vary the quantity of capital that it employs and, as a result, the
marginal revenue product of its capital aries
THE DECISION TO PURCHASE A UNIT OF CAPITAL:
- If the PV is greater than or equal to the purchase price, the firm should buy the
capital good; if the PV is less than the purchase price, the firm should not buy it
A BRIEF OVERVIEW OF THE CAPITAL MARKET:
- Firms require physical capital to produce
- Purchases of new capital equipment are investments
- Also require working capital, which are funds used to acquire physical capital
(materials, labour, etc)
- Firms finance their activities in one of four ways:
a. Retained Earnings
b. Borrow from banks and other financial intermediaries
c. Issuing bonds and thereby borrow directly from lenders
d. Sell stocks for additional capital
- Household saving determines total supply of financial capital
- The illustration below showcases the interaction of firms and households:
- When economists speak of the demand and supply for labour, they are referring
to the flow of labour services
- Example → firm hires the services of a worker for a week, after which the
firm and worker go separate ways
- When a firm considers its demand for physical capital, it is considering
purchasing a new piece of equipment and thereby adding to its stock of capital.
This piece of equipment will have many useful lives
, PRESENT VALUE:
- Present Value → the most that someone would be prepared to pay to get a
specific amount in the future
PRESENT VALUE FORMULA:
- PV = FV/(1 + r)^n
THE PRESENT VALUE OF A STREAM OF FUTURE SUMS:
- To consider the present value of payments that continues for many periods, you
must take into account each period individually
- Example → One new lathe may generate a marginal revenue product equal
to $200 one year from now, $180 two years from now, and $210 three
years from now before it wears out and caesar to generate any further
benefits
- Solution:
THE DEMAND FOR CAPITAL:
- A firm’s demand for financial capital comes from its demand for physical capital
- Economists assume that the amount of physical capital the firm chooses to use
comes from its objective of maximizing profit
THE FIRM’S DEMAND FOR CAPITAL:
- An individual firm faces a given interest rate and a given purchase price of capital
goods
- The firm can vary the quantity of capital that it employs and, as a result, the
marginal revenue product of its capital aries
THE DECISION TO PURCHASE A UNIT OF CAPITAL:
- If the PV is greater than or equal to the purchase price, the firm should buy the
capital good; if the PV is less than the purchase price, the firm should not buy it
