The future MRPs can also increase if the market price for the firm’s
product increases (or if demand for its product increases and it operates
in an imperfectly competitive market). Even without any technological
change, an increase in the firm’s product price leads to an increase in the
MRPs and thus to an increase in the height of the bars in Figure 15-2
the firm would buy more capital at any given purchase price.
Reduction in the Interest Rate
The PV of the stream of MRPs will also increase if the interest rate falls. A
lower interest rate means that future MRPs get discounted at a lower rate
—and therefore have greater present value. Thus, as the interest rate
declines, the firm’s optimal capital stock increases. In Figure 15-2 ,
imagine that the interest rate is 3 percent per year instead of 6 percent. In
this case, the PV of each computer’s stream of future MRPs will rise, and
each bar in the figure will increase in height. For a given purchase price of
computers, the firm will therefore increase its desired stock of computers.
Anything that causes the present value of future MRPs of capital to increase—technological
improvement, an increase in the product’s price, or a reduction in the interest rate—leads firms
to increase their desired capital stock.From Capital Stock to Investment Demand
We have just examined how a profit-maximizing firm determines its
optimal stock of physical capital. It is important to emphasize again the
distinction between stocks and flows—in this case the distinction between
the firm’s optimal stock of capital and its optimal flow of investment. In