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

Units ofcapital

TotalRevenue

Marginal revenueproduct of capital

0 0 --

1 3000 3000

2 4500 1500

3 5000 500

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

13_01

FIRM'S QUANTITY OF CAPITAL

Marginal revenue product of capital

1. When the rental price of capital falls...

2. the quantity of capital demanded rises.

RENTAL PRICE OF CAPITAL

The firm adjusts its capital so that the marginal revenue product of capital equals the rental price. A demand curve for capital results.

Equilibrium in the Market for Physical Capital

13_02

QUANTITY OF CAPITAL IN THE MARKET

Market demand for capital

Market equilibrium price

Market equilibrium quantity

Market supply of capital

RENTAL PRICE OF 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

13_03

QUANTITY OF CAPITAL

New demand for capital

2. lowering the rental price of the capital...

3. but the supply is fixed.

RENTAL PRICE

1. The demand curve shifts to the left...

The supply of capital is fixed.

Old demand for capital

Financial Capital

• debt: promise to pay 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)13_04A

PennzoilPZL

70 3/4 513/8 503/8 -7/8501/4

DivYld%

Vol100s Hi

NetChg

3/4 3.00 6.0

NEW YORK STOCK EXCHANGE

High and lowprice forprevious year

Stockexchangesymbol

High andlow forthe day

Closingprice of stock

Change inprice from previousday

Yearlydividend

Sym PE Lo Cls

52 weeksHi Lo

15 388

Dividend asa percent ofprice

Price-earningsratio

Number ofsharestraded (inhundreds)

45

52 weeks Yld Vol NetHi Lo Stock Sym Div % PE 100s Hi Lo Close Chg

261/2 191/2 Paul Revere PRL .12e .6 . . . 22 197/8 193/4 197/8 . . .163/8 101/2 PaxarCo PXR . . . 21 34 131/8 127/8 137/8 + 3/8

195/8 11 PaylessCash PCS . . . . . . 197 131/2 131/4 131/4 — 1/4

227/8 147/8 Penncpfnl PFG .04 .2 10 108 173/4 171/2 173/4 + 1/4

59 395/8 Penny JC JCP 1.68 3.2 13 6462 531/2 511/4 513/4 — 233 27 PennEntr PNT 2.20 7.2 17 164 303/4 30 301/2 + 1/2

31 191/2 PennP&L PPL 1.67 8.5 10 1177 193/4 195/8 193/4 + 1/8

79 571/8 PennP&L pfb 4.50 7.3 . . . z10 62 62 62 . . .703/4 453/4 Pennzoil PZL 3.00 6.0 15 388 513/8 501/4 503/8 — 7/8

35 233/8 PeopEngy PGL 1.80 7.6 10 253 233/4 235/16 233/4 + 3/8

333/4 201/8 PepBoys PBY .17 .5 29 1532 323/4 315/8 321/2 + 5/8

421/8 297/8 PepsiCo PEP .721 2.4 15 12333 303/4 303/8 301/2 — 1/8

891/2 27 PerkElmer PKN .68 2.3 48 511 30 203/8 30 + 1/2

235/8 143/4 PerkFamR PER 1.30 8.4 13 61 155/8 151/2 151/2 — 1/4

Terminology of bonds

• coupon

• maturity date

• face value

• yield

• market price

Couponrate

NEW YORK EXCHANGE BONDS

Year bondmatures(2003)

Yield tomaturity

Number ofbondstraded

Closingprice

Change inprice fromprevious day

Rate Maturity Yld Vol CloseNetChg

Pennzl 61/2 03 6.0

13_04B

Cur NetBonds Yld Vol Close Chg.

PacTT 7.8s07 8.0 36 971/2 — 11/4

PacTT 71/408 7.8 10 93 + 1/2

PacTT 75/809 8.0 15 957/8 — 1/8

PacBell 71/802 7.4 62 981/4 . . .PacBell 71/233 8.4 25 893/8 + 1/8

PacBell 61/405 7.0 10 883/4 — 1/4

PacBell 67/823 8.1 21 841/2 — 1/2

ParCm 7s03A 8.4 78 83 — 5/8

Pathmk 3zr03 . . . 100 53 . . .Paten 81/412 cv 4 801/2 — 11/2

PaylCsh 91/303 9.6 25 943/4 + 1/4

Pennzl 61/203 6.0 5 109 . . .Pennzl 43/403 5.4 15 883/4 + 3/4

5.0 109 --

13_05

77/8 Feb 21 106:11 106:13 — 1 7.3081/8 May 21 109:06 109:08 — 1 7.3081/8 Aug 21 109:07 109:09 — 1 7.308 Nov 21 107:27 107:29 — 1 7.3071/4 Aug 22 99:13 99:15 — 1 7.2975/8 Nov 22 103:24 103:26 — 1 7.2971/8 Feb 23 98:03 98:05 . . . 7.2861/4 Aug 23 87:31 88:01 . . . 7.28

Monday, April 14, 1997

83/4 Aug 20 129:07 129:09 + 7 6.4577/8 Feb 21 118:03 118:05 + 7 6.4681/8 May 21 121:14 121:16 + 6 6.4581/8 Aug 21 121:16 121:18 + 7 6.458 Nov 21 120:03 120:05 + 8 6.4471/4 Aug 22 110:15 110:17 + 7 6.4475/8 Nov 22 115:14 115:16 + 8 6.4471/8 Feb 23 109:01 109:03 + 6 6.43

Wednesday, August 11, 1993

Rate Maturity Bid Asked Change Yield

88

Nov 21Nov 21

107:27120:03

107:29120:05

-1+8

7.306.44

Coupon on bondas a percent ofthe face value

Date bondmatures:Nov. 2021

Marketpriceof bond

Changefrompreviousday in 1/32 nds

Yieldto maturity

TREASURY BONDS, NOTES & BILLS

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?