9.3 Capital markets and interest rates

Interest, as well as wages, is a form of factor incomes. Owner factor capital receives his income as a percentage.

Capital, as we know, can be defined as the value that generates revenue streams. Under the capital market of production factors mean physical capital, using which you can increase in the future income stream (machines, buildings). Capital is in demand because it is productive. The subject of the demand for capital is business, and entrepreneurs. The subjects of the supply of capital - the household.

Demand for capital - is the demand for investment funds, and not just for money. When we talk about the demand for capital, as a factor of production, we are referring to the demand for investment funds required for the acquisition of capital in its physical form (machinery and equipment). Demand for capital can be represented graphically (Figure 16).

As the investment funds offered reduced product of capital. The same thing happens with the growth of labor hire and reduction of the product of labor.

Supply of capital. Population offers business machines, equipment in their physical expression. Housekeeping offers investment funds, ie amount of money that a business uses to acquire productive assets (Figure 17). Why the supply curve is has a positive slope?

r r

Dc Sc

I I

Fig. 16. Demand for capital Fig. 17. Supply of capital

Presented by the graph in Fig. 18 allows one to understand the category of interest as a kind of equilibrium price: the point of intersection of Dc and Sc, equilibrium in capital markets Dc = Sc. At the intersection of E, equilibrium in the capital market.

r Sc

r - the rate of interest

r o E I – investment resources

E Dc

I 0 I

Fig. 18. Equilibrium in the capital market

At point E a match supply and demand return on capital costs of lost opportunities. Thus, the curve Sc indicates that the subject gives up current consumption of the capital, offering him a loan against future large income. The percentage is the price for the fact that the owner of capital is different constituencies to present current use. But why for the opportunity to pay? Economic theory emphasizes that today's good people rate higher future goods (time preference). Therefore, to encourage the owner to abandon the current capital resource management should reward him for such refusal.

Interest is the price that people pay for something to get resources now rather than wait until as long as they earn the money with which these resources can be purchased. At point E offers a match return.

Interest rate is the ratio of capital income on loan, expressed as a percentage (given in 1000 and received an annual income of 50, the interest rate is 50/1000 * 100% = 5%. Higher the risk, the higher the interest rate. Percentage fulfills an important task of efficient allocation of resources in a market economy, the choice of the most profitable of possible investment projects.

Comparison of return on capital with an interest rate - is one way to study the efficiency of investment projects. Another way, which is of great value and is used not only in the business - a procedure discounting. Category discounting is inextricably linked to the time factor and the role that time plays in general in determining the category of interest.

The problem is that in the implementation of investment projects (purchase of equipment, construction of a new plant, construction of the railway, etc.), you must compare the value of current costs and future income.