Lecture 27 - Announcements HW due Monday (chs. 11-12) Ch 13...

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Announcements HW due Monday (chs. 11-12) Ch 13 HW due Thurs. Next week ch 14, 16 and maybe start 17
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THE CAPITAL MARKET bond A contract between a borrower and a lender, in which the borrower agrees to pay the loan at some time in the future, along with interest payments along the way. financial capital market The part of the capital market in which savers and investors interact through intermediaries. interest rate A fee paid annually expressed as a percentage of the loan or deposit.
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THE CAPITAL MARKET capital income Income earned on savings that have been put to use through financial capital markets. interest The payments made for the use of money. CAPITAL INCOME: INTEREST AND PROFITS
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THE CAPITAL MARKET share of common stock A certificate that represents the ownership of a share of a business, almost always a corporation. Firms share profits with their investors dividend Profits that are paid directly to shareholders. profit The excess of revenues over cost in a given period.
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THE DEMAND FOR NEW CAPITAL AND THE INVESTMENT DECISION Firms have an incentive to expand in industries that earn positive profits—that is, a rate of return above normal—and in industries in which economies of scale lead to lower average costs at higher levels of output. Positive profits in an industry stimulate the entry of new firms. The expansion of existing firms and the creation of new firms both involve investment in new capital.
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THE FIRM’S INVESTMENT DECISION
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THE DEMAND FOR NEW CAPITAL AND THE INVESTMENT DECISION (BASIC) For a firm, the first unit of capital may provide a big return but each additional until might provide less and less return (holding all other inputs constant) – diminishing marginal product. A profit-maximizing firm will keep investing in new capital up to the point at which the expected rate of return is equal to the interest rate (or discount rate ). This is analogous to saying that the firm will continue investing up to the point at which the marginal revenue product of capital is equal to the price of capital, or MRP K = P K , which is what we learned in Chapter 11. But the time dimension adds a twist when we talk about capital.
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DETAIL) The Expected Benefits of Investments The investment process requires that the potential investor (the firm) evaluate the expected flow of future productive services that an investment project will yield. This is also called the Marginal Revenue Product of capital. The Expected Costs of Investments If the firm needs to borrow the money for the investment, the cost is the interest they have to pay on the loan plus the cost of paying the loan back.
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This note was uploaded on 12/20/2011 for the course ECON 2005 taught by Professor Zirkle during the Fall '07 term at Virginia Tech.

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Lecture 27 - Announcements HW due Monday (chs. 11-12) Ch 13...

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