When a higher stream of rental earnings is anticipated, buyers are willing to pay a higher purchase price for capital assets; but with lower anticipated streams they find it profitable to demand capital goods only if their price is lower: there is a downward sloping demand. The upward sloping supply and downward sloping demand together determine the quantity and price of capital goods in the economy. In turn this determines the flow of capital services.
What happens to the price of capital assets when an industry faces a decline in its demand for capital services, as in Figure 12.8? In the short run the return on the fixed capital services
falls to R
. The capital that is in use in this sector of the economy
is now less valuable on account of the lower return it is generating. If capital elsewhere in the economy can still earn a return of Ro, then capital in this one sector will be allowed to
depreciate. This depreciation continues until capital services in the industry become sufficiently scarce that the rental rate returns to its original level. At this point the present value of
future rentals matches the price of capital goods in the whole economy, and the industry begins to replace its depreciating capital once again. A new LR equilibrium in the industry is attained
at K
.
- 831 reads
