--> equilibrium price and quantity of the factor to maximise the profit
Rental rate for users
For the market: Market determines the rental rate, and businesses borrow that capital at the equilibrium price
Individual firm:
--> employ the amount of people (Q1) at the rate of Re
Rental rate for suppliers
The suppliers are price takers since they will need to take the rental price established in the market because
customers are likely to turn to rivals when they change the price, making the curve perfectly inelastic (straight
horizontal line)
Supply curve more elastic in the short run because you cannot change the capital
Labour can change in short run
INVESTMENT APPRAISAL
Find out whether the investment we are making is profitable and the risk of investment
Economics for Management (LUBS 1940) Page 13
, Find out whether the investment we are making is profitable and the risk of investment
Calculating the returns while taking "discounting" into consideration - the decline in value of investment today,
affecting the returns in future
Two type of discounting:
1. Present value approach - estimating the present value while taking the flow of future benefits(or costs)
2. Rate of return approach - percentage of the benefits to the costs of investment
*government investment decisions - hard to measure the return and there are other considerations other than NPV,
such as:
- Non-monetary costs and benefits
- Political considerations (winning elections)
SUPPLY OF CAPITAL
Loanable funds and interest rate equilibrium
Calculate the costs of capital
Firms can source finance through:
- Retained profits
- Borrowing money from banks
- Issuing shares
Costs of capital:
- Leverage (measure of how much the firm relies on loan) and the risks to suppliers of providing loan to the firm
- Measures of leverage:
○ Gearing ratio - ratio of debt to total finance
○ Debt/equity ratio - ratio of debt finance to equity finance
FINANCING INVESTMENT
Source of business finance:
- Internal sources
- External sources
- International sources
○ International finance institutions
*You can get advice and help from the financial sector in the market
The banking system:
- Retails banking - daily high street banks, help operating transactions across individuals and firms
- Wholesale banking - receiving large deposits from and making large loans to companies or other banks and
financial institutions (also known as investment bank in the past)
- Universal bank - bank conduct both retail and wholesale banking
○ Problem: 2008 financial crisis where the universal banks products bundled uup sound assets with highly
risky ones
THE STOCK MARKET
Primary market - firms issue shares first hand to shareholders
Secondary market - shareholders resell their shares to others
Advantages:
- Regulate firms, help encourage confidence
- Brings tgt savers and firms seeking investment
Disadvantages:
- Stock market suffers from short-termism, where the shareholders only focus on short term performance
rather than long term
- Losing control in the stock market
Efficient market hypothesis
Showing how efficient is the stock market in pricing securities
Capital markets are efficient when the shares are priced at the value that reflect what they are worth, ie the
companies' current and future performance
Example: investment analyst found that the share of a company is undervalued (inefficient), investors will then buy
the share of that company, bumping the price of the company (making it efficient)
Free rider - someone in the market gaining benefits without paying for them
Week 13
Government and Market
Economics for Management (LUBS 1940) Page 14
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