1. Chapter 17: Capital and Financial Markets

2. Capital
Capital = buildings and equipment used to produce output

3. Capital Capital = buildings and equipment used to produce output
Do not confuse capital with “financial capital”

4. 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)

5. 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)

6. Demand for capital
Tied to the MRP of capital over the course of its productive life.

7. 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.

8. 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

9. Present value
$1000 received today is worth more than $1000 received in 5 years.

10. 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.

11. 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.

12. 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 more capital is used

13. 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.

14. Demand and supply of capital
An increase in the interest rate results in a reduction in the equilibrium quantity of capital sold

15. 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

16. Coupon bonds
Coupon bonds are corporate bonds that provide a fixed coupon payment each year

17. 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

18. 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

19. 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 payments + capital gains (or losses)

20. Discount bonds
Bonds that are sold at a price below the face value

21. 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

22. Risk and rate of return
Riskier assets provide a higher yield

23. Stock prices
Determined by the interaction of the demand for and the supply of stock

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