So I'm reading about capital.

My book claims that households (via their savings) *supply* capital to firms who *demand* it.

This makes sense if you assume that firms *always* borrow money to pay for capital.

But here's the part I don't get - what if the firms just pay for the capital out of their own money?

Why is it a *necessary* part of the system that it comes from loans which are provided by the savings of households?

Are you reading 'Economics for Idiots' ??

I should clarify to everyone two things if you're not in econ or familiar with the terminology.

In economics, "investment" means the purchasing of capital. It's not like buying a bond, the way regular people usually use the term. It refers to the building of a factory, or the going to school to learn IT, that kind of thing. The purchase of new capital stock.

Capital is not money - capital is the set of all goods that facilitates the output of goods demanded by people - not the goods themselves.

So a robot arm to make Ferraris, or an education of a heart surgeon to save granny's life, or inventory of Oral-B so that they have enough toothbrushes for people in the future, or goodwill generated by Nature Valley who spends money supporting national parks and causes me to appreciate them as a company.

No. "Principles of Microeconomics" by Case, Fair, and Oster. Why do you say that Nigee

Capital goods are usually expensive, and borrowing to pay for them enables firms to spread the cost out over a long period of time. The loan comes from a bank, who borrows the money from households.

Or they can borrow directly from households if they're issuing corporate bonds. Money gon' get there some kind of way.

^^this deals more with capital structure of firms.

Most of a firm's "capital" is locked up in non-liquid assets, Accounts receivable, inventory, etc. This means that to pay off debts such as salary, purchases, etc. firms need to use credit. Also, it is very, very rare that firms would have enough money to pay for expansion on their own. Only mega-firms such as ones in the S&P 500 have enough equity to pay for their own investments (such as building a new factory, etc). But on average, if Joe's pizzeria wants to buy a new building or add an extension, Joe needs to borrow from the bank.

Also, as I'm learning in finance right now, leveraging (borrowing debt) actually *increases* a firm's Return on Equity, which stockholders like very much. Since every firm's goal (in theory) is to maximize stock value, they will choose the route which will give them and their shareholders the highest ROE. This means they will mix their borrowing from debt and equity.

Right right. I understand the whole process of the borrowing.

I'm asking why it is that economics seems to so confidently declare that

"households (via savings) are the supply of capital"

How can that be if you could theoretically have a company that never borrows any money and pays for capital out of pocket?

Would it not be more accurate to say that households' savings are a *part* of the supply of capital?

Another part would be the money firms have in hand, would it not?

And in the end, all money will flow back to the firms for their capital structure. Besides the domestic lending aspect of banking (home mortgages, car loans, etc) all banks will either purchase bonds (which are issued to raise capital to pay for a firms' needs) or in direct lending to the firms themselves.

The vast majority of companies are not sitting on huge piles of cash. A company that sells widgets needs to pay for materials, salaries, space, electricity, etc. before it can actually sell the widget; that requires capital. That capital is borrowed in the form of loans, and then repaid once the widgets are sold. The profit from selling the widgets is usually not enough to cover the costs of production for the next batch of widgets, hence the need for continuous borrowing for most companies.

I personally know of one company that went under when the depression hit because the banks stopped loaning money, even though the company was fairly profitable. As a result, this company could not afford to pay for the raw materials to make their product, which resulted in a lot of really ticked off customers and lost business, which resulted in the company going under even though it would've remained entirely profitable if their access to capital had not been cut off by the banks.

Ideally, companies would be able to fund their operations with cash reserves. But this is not very practical given the size, complexity, and relatively low profit margins of most companies.

I also understand that yeah usually it's too much money to pay up front so they borrow, but it's the "usually" that's got me hung up.

If it's "usually" how can you take a statement that only "usually" is the truth and start using it to do more complex math as if it was a natural law? It's weird.

Then you've got the most insanely profitable firm ever and potential creditors will be lined up around the block to lend them money. They'll break and borrow some eventually.

And, even if a company has more money than God (Apple), they still rarely spent it, preferring to keep it incase shit hits the fan.

Lol guys, Tolstoy, goldfinger, AWB I'm not questioning the truth or logic of borrowing.

I'm just saying that I don't understand how my book can make a blanket claim when it's only actually true "usually" or "for the majority"

do you see what I mean?

Thanks for the help btw this is good

Okay but say I am a company with $10 billion in cash.

Are you saying that this company will *still* *always* borrow $100 million for a new factory instead of just paying for it?

I don't get that, if it's true.

Thucy: "If it's "usually" how can you take a statement that only "usually" is the truth and start using it to do more complex math as if it was a natural law? It's weird."

Stop right there, back the fuck up, and repeat after me: "The discipline of economics does not completely describe human behavior, and only describes it accurately some of the time."

There should be a big ol' list of assumptions that the discipline of economics makes somewhere up in the front of your textbook. It'll talk about imperfect information, animal spirits, and other weird non-euclidean shapes that float around just outside of the field of vision of the economist and give him nightmares about being eaten by elder gods.

Be very, VERY careful about making economics the center of your worldview. It provides a nice, neat picture, but that's just because it simplifies a lot and ignores even more.

also, inb4 TC comes in this thread to berate me for studying economics, as if he doesn't yell at me to do exactly that all day long. lol.

I don't really understand your question, Thucy. That is to say, I don't think the sentence actually implies what you say it does. Why does the fact that "households (via their savings) supply capital to firms who demand it" imply in any way that firms can't also acquire capital using their own savings? It doesn't. It just means that that isn't enough for what they want to do, or that they've decided not to do so at the present time. Period.

Thucy

Apple *does* have $100 Billion in cash. They still get loans.

I don't think there's a single person on the face of the planet that's actually in favor of businesses that aren't banks or insurance companies keeping large cash reserves.

Oh, yeah I get that too AWB. Believe me lol I'm in no danger of treating my econ book like the Bible.

It's just that up to now the words it used were such that they could be considered absolutely true in a market economy.

Such as "households supply labor to firms".

But now they are saying "households supply capital to firms" and I'm like... okay I can see how they supply *some*, IF all firms decide to pay for ALL capital by borrowing.

But if anyone doesn't the statement becomes partly false.

I dunno I guess you're probably right AWB it's just one of those things where they use language a little too sweepingly.

I'll just take "it's usually the case" and go back to my chapter I guess.

Thanks yall.

"I'm just saying that I don't understand how my book can make a blanket claim when it's only actually true "usually" or "for the majority""

The question you should be asking is "who benefits from a system where all college students are taught that borrowing massive amounts of money at interest is the lone path to success in business?"

"But now they are saying "households supply capital to firms" and I'm like... okay I can see how they supply *some*, IF all firms decide to pay for ALL capital by borrowing.

But if anyone doesn't the statement becomes partly false"

Again, Thucy, I think this is really bad interpretation (sorry). What you say would only be true if the sentence was "households supply ALL capital to firms."

If I send you $100, I can say, "I supply money to Thucy." That in no way implies that you don't have other sources of income.

(OK, bad example maybe....)

@abge

Yeah exactly I'm asking why does Apple do that - if your choice is pay $10 million from your pocket or borrow it and pay $11 million overall, why would you choose the latter?

@semck

I guess you have to read in the context of the rest of the textbook up to here, which has been saying "households supply labor to firms" and when it says that it means "ALL labor employed by firms comes from households" which is incidentally true.

It's like saying "energy on earth is supplied by the sun"

This is true. But if I said "fresh water is supplied to humans by lakes."

That would be a weird statement, because we also get it from rain, rivers, dew, desalinization... you see what I mean by that now?

^^Thucy, depending on what level course it is, its probably just generalizations. I took Intermediate micro and they're still doing generalizations. The point is that savings goes to firms to make capital. If you wanted to get nit-picky about it then you'd have to remove the amount needed for the reserve requirement and see how much it increases the M1 money supply and then see how much banks lend to other households before you get to the absolute amount that goes to firms.

So if this is intro or immediate level, then have a discussion with your professor about it. He/she will enjoy the talk and it'll earn you some brownie points

Speaking of shrieking horrors that we don't talk about twisting through the endless abyss between universes, why are there people who haven't muted TC yet? Ever since I muted TC, my credit score has gone up, I've lost ten pounds, and my dick grew two inches.

Thucy, I think the book is just using the word more flexibly than you're allowing. Also, energy on earth isn't all supplied by the sun -- there's nuclear power too. So, you see? Even in that example, the missing "all" was important.

@ AWB

In which direction?