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The Return on Capital Rate of return on investment π – rate of return on investment C=R1/(1+π)+R2/(1+π)2+…+Rn/(1+π)n C – cost today Ri – return in year i Invest if Expected rate of return market interest rate * The Return on Capital Demand for loanable funds Market interest rate Loanable funds - firm Market demand curve - loanable funds Horizontal sum Demand curves - individual firms Market supply curve - loanable funds Horizontal sum Individual supply curves * Figure 26.13 The demand for loanable funds by a firm * At each interest rate, the firm will demand a quantity of loanable funds sufficient to finance all those investment projects with rates of return greater than the interest rate Loanable funds 0 Market rate of interest (r) 7% 5% $2,000,000 $1,500,000 Figure 26.14 The market demand curve for loanable funds * The market demand curve for loanable funds is the horizontal sum of the demand curves for loanable funds of all the individual firms in the market 0 Interest (r) Firm 1 Firm 2 Firm 3 Market 0 Interest (r) 0 Interest (r) 0 Interest (r) 7% 5% $1,000 Demand Demand Demand Demand $1,500 $600 $1,000 $500 $700 $2,100 $3,200 The Return on Capital Market for loanable funds Equilibrium Intersection: demand and supply Market rate of interest Amount of funds Market rate of interest Determines - return on capital Equilibrium - market for loanable funds Marginal rate of return = market rate of interest * Figure 26.15 The market for loanable funds * The equilibrium interest rate is determined at the intersection of the market supply curve section for loanable funds and the market demand curve for loanable funds Loanable funds 0 Interest D S E r* K* The Return on Land Rent - Return on factor Above amount Necessary - production process Supply of land - Perfectly inelastic Price of land Determined - demand curve Demand Determined - profitability of land Different uses * Rent Figure 26.16 The market determination of rent * The equilibrium rent on land, re , is d
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