Types of Capital Physical Capital trucks computers buildings

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 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?