Chapter 27 Capital & Interest

Chapter 27 Capital & Interest - Capital...

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Unformatted text preview: Capital & Interest Wealth of Nations Saving, Investment, and Capital Formation Capitalization Chapter 27 Prelude to Macro Capital and interest is a great topic to introduce macroeconomics. Up to this point, all the principles that we have studied have very important macro implications, such as the Law of Comparative Advantage, the Price and Wage Equalization Principle, the Rate-of-Return Equalization Principle, and the Invisible Hand Principle. Nonetheless, the topic introduced now is one of the most important and controversial lessons with respect to macro and the wealth of nations . Learn these lessons well! Again, what is capital? Human-made resources that indirectly produce consumption goods Examples: bucket, shovel, nuclear power plantphysical thing not like financial capital like bank accounts Capital accumulation (or formation) Increasing capital stock Capital depreciation Capital wearing out (over time, washer machine breaks down, etc.) Capital consumption Decreasing (reducing) capital stocknot keeping up with What is investment? The act of creating capital Physical capital: axe, light bulb Human capital: training, education 1 2 3 23 24 25 years Illustrating capital formation and consumption. Tree farm example: A farmer plants 1,000 trees per year, which take 25 years to mature. Income per year after 25 years? 1000 trees What would happen eventually if the farmer dipped into his capital and cut younger trees in order to have a higher income one year? Consumption of capital, not as many trees (capital) so then has to cut into younger trees to maintain the 1000 tree income. Eventually face reduced income (standard of living is lowered) National implications?! Many nations constantly consume their capital (Haiti) Source of economic growth: Savings! Savings = production (income) consumption. Savings is required for capital formation. R. Crusoe model makes the point clear. Initially, labor and land onlyno capital. Crusoe has to create capital. In order to create capital (net), Crusoe must initially save enough provisions (fish) to support himself while taking time from fishing to make the net . (Ditto for the canoe, except the canoe requires more savings.) Labor Fish per day Days to build Growth (300 days) Land (spear) 3 900 fish Capital (net) 4 30 1200 fish Capital (canoe) 6 90 1800 fish Expanding PPC with saving & investment The trade-off between now & later Consumption goods Capital Goods or Investment Goods 2000 2000 1960 Japan Argentina New investment...
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This note was uploaded on 04/01/2012 for the course ECON 101 taught by Professor Balaban during the Fall '07 term at UNC.

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Chapter 27 Capital & Interest - Capital...

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