profit-maximizing firm is simple: If the PV is greater than or equal to the
purchase price, the firm should buy the capital good; if the PV is less than
the purchase price, the firm should not buy it.
Consider the following simple example. Suppose a computer appropriate
for high-quality graphic design has an MRP of $1000 each year—that is,
by buying this computer a graphic-design firm can produce more output
and thereby increase its revenues by $1000 each year. Suppose further
that the computer delivers benefits this year (now) and for two more
years—after that, the computer is completely obsolete and worth nothing.
Finally, suppose the interest rate is 6 percent per year. The PV of this
stream of MRPs is then equal to
The present value tells us how much this flow of future receipts is worth
now. If the price of the computer is less than $2833.40, the firm should
buy it; if the price is higher, the firm should not buy it.
If a firm wants to maximize its profits, it is worthwhile to buy another unit of capital whenever
the present value of the stream of future MRPs generated by that unit equals or exceeds its
purchase price.The Firm’s Optimal Capital Stock
Because of the law of diminishing marginal returns, the MRP of each unit
of capital generally declines as the firm buys more capital. The profit-
PV = $ 1000 + +
= $2833.40$ 1000
(1.06)$ 1000
(1.06)^2