Types of Capital Physical Capital –trucks, computers, buildings Financial Capital –bonds, corporate stocks Human Capital –skills, education

To derive demand for physical capital First, consider the case where capital is rented –The firm must pay a rental rate for the capital

Numerical Example

To derive the demand curve for physical capital, sketch a graph showing the marginal revenue product of physical capital

A Smooth Looking Demand for Physical Capital

Equilibrium in the Market for Physical Capital

For the case where firms own the capital There is an implicit rental price of capital –implicit rental price equals interest plus depreciation –example: price of overhead projector = $4000 interest rate =.10 (10 percent) depreciation = $1000 implicit rental rate = (.10)($4000) + $1000 = $1400

special case where supply is fixed

Financial Capital debt: promise to pay to pay interest and principal in the future –examples: corporate bonds, government bonds equity: payment of dividends depends on firm’s profits –example: corporate stock stocks or bonds are traded on the stock market or the bond market--BIG QUESTION: WHAT DETERMINES PRICE?

Terminology of stocks return = dividend plus capital gain rate of return = return as a percent of price dividend yield earnings price-earnings ratio

July 1, 1994 (Wall Street Journal)

Terminology of bonds coupon maturity date face value yield market price

Relationship between yield and price of a bond? F = face value R = Coupon P = price i = yield For a one year bond: i = (R+F-P)/P Or, P = (R+F)/(1+i) This is the present discounted value of next year’s F and R

What determines the price of a bond? First, let’s auction off a bond and see what happens?