Investment and the Employment of Capital. The Pricing of Capital and Capital Services Factor prices...
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Transcript of Investment and the Employment of Capital. The Pricing of Capital and Capital Services Factor prices...
The Pricing of Capital andCapital ServicesThe Pricing of Capital andCapital Services
• Factor prices versus the price of factor services
– factor prices and factor rental rates
– stocks and flows
• Profit maximising employment of capital
– marginal cost of capital (MCK)
– marginal revenue product of capital (MRPK)
– profit maximising in perfect capital markets
The Pricing of Capital andCapital ServicesThe Pricing of Capital andCapital Services
• Factor prices versus the price of factor services– factor prices and factor rental rates
– stocks and flows
• Profit maximising employment of capital– marginal cost of capital (MCK)
– marginal revenue product of capital (MRPK)
– profit maximising in perfect capital markets
– profit maximising given monopsony power in capital markets
Firm with monopsony power in factor marketFirm with monopsony power in factor market
O Q of factor
£
MRPf
ACf = S
MCf
O Q of factor
£
MRPf
ACf = S
Qf2
Pf2
MCf
Firm with monopsony power in factor marketFirm with monopsony power in factor market
The Demand for and Supply ofCapital ServicesThe Demand for and Supply ofCapital Services
• The demand for capital services– individual firm’s demand
– market demand
• The supply of capital services– supply to a single firm
– supply by a single firm• short-run MC
• long-run MC
– market supply
• The price of capital services
S
D
O
Re
Qe
Ren
tal r
ate
(£)
Quantity per period
Long-run equilibrium rental rate in the market for capital servicesLong-run equilibrium rental rate in the market for capital services
O
MRPK
Re
MCK = S
Q1
Ren
tal r
ate
(£)
Quantity per period
An individual user of capital servicesAn individual user of capital services
O
Re
Quantity per periodQ2
D
S
An individual supplier of capital servicesAn individual supplier of capital servicesR
enta
l rat
e (£
)
Investment AppraisalInvestment Appraisal
• Capital for purchase: investment
• Investment demand– calculating the benefits of investment
– discounting• present value approach
• rate of return approach
– the risks of investment
• The supply of capital– supply of physical capital
– supply of finance
The market for loanable fundsThe market for loanable funds
O
% r
ate
per
year
Quantity of loanable funds
D
S
O
D
% r
ate
per
year
Quantity of loanable funds£e
ie
S
The market for loanable fundsThe market for loanable funds
Investment AppraisalInvestment Appraisal
• Calculating the costs of capital– sources of investment finance
• retained profits
• borrowing from the banking sector
• share issue
– leverage and the cost of capital• leverage and the risks to suppliers
• measures of leverage– gearing ratio
– debt / equity ratio
The debt / equity ratioThe debt / equity ratio
O
Cos
t of c
apita
l (%
)
Ratio of debt to equity
Cost of equity
Cost of debt
O
Cos
t of c
apita
l (%
)
Ratio of debt to equity
Cost of equity
Cost of debt
Weighted average costof capital
The debt / equity ratioThe debt / equity ratio
Investment AppraisalInvestment Appraisal
• Calculating the costs of capital– sources of investment finance
• retained profits
• borrowing from the banking sector
• share issue
– leverage and the cost of capital• leverage and the risks to suppliers
• measures of leverage– gearing ratio
– debt / equity ratio
– risk premia
Financing InvestmentFinancing Investment
• Sources of business finance
– internal sources
– external sources
• short-term finance
• medium-term finance
• long-term finance
– international sources
– comparison of the UK with other EU countries
Financing InvestmentFinancing Investment
• The role of the financial sector– expert advice– expertise in channelling funds– maturity transformation– risk transformation
• Financial institutions in the UK– retail banks– investment banks (wholesale banks)
• merchant banks• overseas banks
– finance houses
The Stock MarketThe Stock Market
• The role of the Stock Exchange– primary market– secondary market– advantages
• brings together savers & firms seeking investment
• regulates firms & helps instil confidence• facilitates mergers and takeovers• reduces transaction costs of investment
finance
– disadvantages• cost of getting listed• possible short-termism and instability
The Stock MarketThe Stock Market
• Is the stock market efficient?– the efficient market hypothesis
– weak form of efficiency• where share dealing prevents cyclical
fluctuations in share prices
– semi-strong form of efficiency• where share prices adjust fully to publicly
available information
• chances, however, of 'insiders' gaining
– strong form of efficiency• where share prices adjust fully to all relevant
information (including 'inside information')