Capital = buildings and equipment used to produce output ..

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Chapter 17 Capital and Financial Markets
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Capital

• Capital buildings and equipment used to produce
  output
• Do not confuse capital with financial capital
• Gains from roundabout production (producing
  goods that are used to produce other goods)
• Capital accumulation requires savings (forgone
  consumption)

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Demand for capital

• Tied to the MRP of capital over the course of its
  productive life.
• Since capital lasts for a long period, firms must
  take into account the marginal revenue generated
  by capital and its marginal cost over its entire
  productive life.
• Additional capital is used if the present value
  of the additional benefits is higher than the
  present value of the additional cost.
• Present value current value of future benefits

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Present value

• 1000 received today is worth more than 1000
  received in 5 years.
• Present value of a future balance amount that
  must be given up today to receive that amount at
  the specified future date.

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Capital demand curve

• At a given interest rate, the capital demand
  curve relates the present value of the MRP of
  capital to the amount of capital used
• Holding other resources constant, MRP of capital
  declines as capital use rises

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Capital demand and the interest rate

• As the interest rate rises, the present value of
  the MRP stream declines, leading to a reduction
  in the demand for capital.

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Demand and supply of capital

• An increase in the interest rate results in a
  reduction in the equilibrium quantity of capital
  sold

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Financial capital

• Two types of returns from owning stock
• Dividends
• Capital gains
• Annual return on stock return from dividends
  change in the value of the stock

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Coupon bonds

• Coupon bonds are corporate bonds that provide a
  fixed coupon payment each year
• The market price of a coupon bond may be above or
  below its face value
• As interest rates rise, the price of coupon bonds
  falls
• The one-year return from a coupon bond coupon
  rate capital gains (or losses)

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Discount bonds

• Bonds that are sold at a price below the face
  value
• Yield on these bonds is due to capital gains over
  the holding period

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Risk and rate of return

• Riskier assets provide a higher yield

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Stock prices

• Determined by the interaction of the demand for
  and the supply of stock
• Stock prices rise in response to higher expected
  profits