Download Chapter 14 Capital and land

Factor markets and income
distribution
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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.
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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.
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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.
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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.
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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.
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Future consumption
The equilibrium real interest rate
AA' shows the production
possibility frontier between
current and future
consumption:
A'
by devoting resources to
investment, future
consumption can be
increased.
A
The slope of the frontier
has magnitude –(1 + i)
where i is the rate of
return on investment.
Current consumption
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Future consumption
The equilibrium real interest rate
U
A'
E
A
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.
The slope of the red line
represents –(1 + r),
U where r is the real interest
rate that balances the
productivity of investment
and the thriftiness of
consumers.
Current consumption
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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 equalised across
alternative uses.
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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.
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The functional distribution of income in the UK
100%
80%
60%
40%
20%
0%
1981-89
Employment
1999
Self-employment
Profits & rents
The distribution of income between the factors of
production changed little between 1981-89 and 1998.
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