Marcro micro econmiy david begg chapter 014

Chapter 14
Capital and land:
completing the analysis of factor markets

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith


Capital and land
Physical capital
–

the stock of produced goods which
contributes to the production of goods
and services

Land
–

the factor of production which nature
supplies

Together capital and land make up
the tangible wealth of a country.
14.2


Investment
Capital depreciates over time
–

becoming less productive and less valuable

Gross investment
–

the production of new capital goods and the
improvement of existing capital goods

Net investment
–

gross investment minus the depreciation of the
existing capital stock
14.3


Stocks and flows
A stock
–
–

the quantity of an asset at a point in
time
the asset price is the sum for which the
stock can be bought outright

A flow
–
–

the stream of services that an asset
provides during a period
the rental rate is the cost of using
capital services
14.4


Interest and present value
The present value of £1 at some future date is the
sum that, if lent out today, would accumulate to
£1 by that future date.
–

It depends upon how far into the future the sum
accumulates

–

and on the rate of interest

The price of a capital asset should be related to
the stream of future payments that will be earned
from the services it provides
–

discounted back to give the present value.

14.5

Real and nominal interest rates
The nominal interest rate
–

tells us how many actual pounds will be
earned in interest by lending £1 for one year.

The real rate of interest
–

measures the return on a loan as the increase
in goods that can be purchased rather than as
the increase in the nominal value of the loan
fund.

The real rate of interest is the nominal rate
minus the inflation rate.
14.6


Future consumption

The equilibrium real interest rate

A'

AA' shows the production
possibility frontier between
current and future

consumption:
by devoting resources to
investment, future
consumption can be
increased.
The slope of the frontier
has magnitude –(1 + i)
A
where i is the rate of
return on investment.
Current consumption
14.7


Future consumption

The equilibrium real interest rate
Given society's preferences
between present and future
consumption, the optimal
position is at E, where the
indifference curve UU is at
a tangent to the PPF.

U
A'
E

U The slope of the red line
A

Current consumption

represents –(1 + r),
where r is the real interest
rate that balances the
productivity of investment
and the thriftiness of
consumers.

14.8


The markets for capital and land
The derived demand curve for capital
(and for land) services closely
parallels the earlier analysis of
labour demand.
But land is in fixed supply to the
economy as a whole.
Rental rates tend to become
equalized across alternative uses.
14.9


Changes in capital intensity
Over time, the UK economy is
becoming more capital-intensive
–

–
–

the wage-rental ratio has increased,
leading industries to substitute capital
for labour
in the long run the supply of labour is
less elastic than the supply of capital
new capital embodies latest technology
14.10


The functional distribution of income in the UK
100%
80%
60%
40%
20%
0%
1981-89
Employment

1998
Self-employment

Profits & rents

The distribution of income between the factors of
production changed little between 1981-89 and 1998.
14.11