1. Investment and the Employment of Capital

2. The Pricing of Capital and Capital Services Factor prices versus the price of factor services –factor prices and factor rental rates –stocks and flows Profit maximising employment of capital –marginal cost of capital (MC K ) –marginal revenue product of capital (MRP K ) –profit maximising in perfect capital markets

3. Perfectly competitive factor market O Q of factor £ MRP f Pf1Pf1

4. O Q of factor £ MRP f Qf1Qf1 Pf1Pf1 Perfectly competitive factor market

5. The Pricing of Capital and Capital Services Factor prices versus the price of factor services –factor prices and factor rental rates –stocks and flows Profit maximising employment of capital –marginal cost of capital (MC K ) –marginal revenue product of capital (MRP K ) –profit maximising in perfect capital markets –profit maximising given monopsony power in capital markets

6. Firm with monopsony power in factor market O Q of factor £ MRP f AC f = S MC f

7. O Q of factor £ MRP f AC f = S Qf2Qf2 Pf2Pf2 MC f Firm with monopsony power in factor market

8. The Demand for and Supply of Capital Services The demand for capital services –individual firm’s demand –market demand The supply of capital services –supply to a single firm –supply by a single firm short-run MC long-run MC –market supply The price of capital services

9. S D O ReRe QeQe Rental rate (£) Quantity per period Long-run equilibrium rental rate in the market for capital services

10. O MRP K ReRe MC K = S Q1Q1 Rental rate (£) Quantity per period An individual user of capital services

11. O ReRe Quantity per period Q2Q2 D S An individual supplier of capital services Rental rate (£)

12. Investment Appraisal Capital for purchase: investment Investment demand –calculating the benefits of investment –discounting present value approach rate of return approach –the risks of investment The supply of capital –supply of physical capital –supply of finance

13. Investment Appraisal Determination of the rate of interest

14. The market for loanable funds O % rate per year Quantity of loanable funds D S

15. O D % rate per year Quantity of loanable funds £e£e ieie S The market for loanable funds

16. Investment Appraisal Calculating the costs of capital –sources of investment finance retained profits borrowing from the banking sector share issue –leverage and the cost of capital leverage and the risks to suppliers measures of leverage –gearing ratio –debt / equity ratio

17. The debt / equity ratio O Cost of capital (%) Ratio of debt to equity Cost of equity Cost of debt

18. O Cost of capital (%) Ratio of debt to equity Cost of equity Cost of debt Weighted average cost of capital The debt / equity ratio

19. Investment Appraisal Calculating the costs of capital –sources of investment finance retained profits borrowing from the banking sector share issue –leverage and the cost of capital leverage and the risks to suppliers measures of leverage –gearing ratio –debt / equity ratio –risk premia

20. Financing Investment Sources of business finance –internal sources –external sources short-term finance medium-term finance long-term finance –international sources –comparison of the UK with other EU countries

21. Financing Investment The role of the financial sector –expert advice –expertise in channelling funds –maturity transformation –risk transformation Financial institutions in the UK –retail banks –investment banks (wholesale banks) merchant banks overseas banks –finance houses

22. The Stock Market The role of the Stock Exchange –primary market –secondary market –advantages brings together savers & firms seeking investment regulates firms & helps instil confidence facilitates mergers and takeovers reduces transaction costs of investment finance –disadvantages cost of getting listed possible short-termism and instability

23. The Stock Market Is the stock market efficient? –the efficient market hypothesis –weak form of efficiency where share dealing prevents cyclical fluctuations in share prices –semi-strong form of efficiency where share prices adjust fully to publicly available information chances, however, of 'insiders' gaining –strong form of efficiency where share prices adjust fully to all relevant information (including 'inside information')