• A modem industrial economy has accumulated large stocks or capital goods. These are the machines, buildings, and inventories that are so Vital to an economy’s productivity. • The annual dollar earnings on capital are called rentals: When we divide the net earnings (rentals less costs) by the dollar value of the capital generating the rentals, we obtain the rate of return-on capital (measured in percent per year).
• Capital is financed by savers who lend funds and hold financial assets. The dollar yield on these financial assets is the interest rate, measured in percent per year.
• Capital goods and financial assets generate a stream of income over time. This stream can be “converted into a present value, that is, the value that the stream of income would be worth today. This conversion is made by asking what quantity of dollars today would be just sufficient to generate the asset’s stream of income at going market interest rates.
• Profits are a residual income item, equal to. total revenues minus total costs. Profits contain elements of implicit returns (such as return on owners’ capital), return for risk bearing, and innovational profits.
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