Capital markets are the channels through which firms obtain financial resources to buy physical factors of production that economists call capital. The available financial resources come from savings. The real interest rate is the return on capital and is the “price” determined in the capital market. This chapter provides knowledge of capital markets. | Capital Markets Capital markets are the channels through which firms obtain financial resources to buy physical factors of production that economists call capital. The available financial resources come from savings. The real interest rate is the return on capital and is the “price” determined in the capital market. Capital Markets Since 1960 the quantity of capital has increased by 166 percent. The real interest rate has fluctuated but has shown no trend. Capital Markets Figure (b) shows the changes in the demand for and supply of capital that have changed the equilibrium quantity and real interest rate over the last four decades. Capital Markets The Demand for Capital A firm’s demand for financial capital stems from its demand for physical capital. The firm employs the quantity of physical capital that makes the marginal revenue product of capital equal to the price of the capital. The returns to capital come in the future, but capital must be paid for in the . | Capital Markets Capital markets are the channels through which firms obtain financial resources to buy physical factors of production that economists call capital. The available financial resources come from savings. The real interest rate is the return on capital and is the “price” determined in the capital market. Capital Markets Since 1960 the quantity of capital has increased by 166 percent. The real interest rate has fluctuated but has shown no trend. Capital Markets Figure (b) shows the changes in the demand for and supply of capital that have changed the equilibrium quantity and real interest rate over the last four decades. Capital Markets The Demand for Capital A firm’s demand for financial capital stems from its demand for physical capital. The firm employs the quantity of physical capital that makes the marginal revenue product of capital equal to the price of the capital. The returns to capital come in the future, but capital must be paid for in the present. So the firm must convert the future marginal revenue product of capital to a present value. Capital Markets Discounting and Present Value Discounting is converting a future amount of money into a present value. The present value of a future amount of money is the amount that, if invested today, will grow to be as large as that future amount when the interest that it will earn is taken into account. The easiest way to understand discounting is to begin with the relationship between an amount invested today, the interest that it earns, and the amount it grows to in the future. The time value of money. It is easy to motivate this topic. Students pay attention when you tell them that understanding discounting present value calculations will help them decide whether it is a good idea to take a bigger student loan, how fast to pay off the loan when they graduate, whether to rent an apartment or buy one with the help of a mortgage, and how much to save to provide a retirement .
