firms to substitute other factors of production for capital The demand for capital, therefore, would fall Changes in Tax Policy Government can indirectly affect the price of capital through changes in tax policy For example, suppose the government enacts an investment tax credit for businesses, that is, a deduction of a certain percentage of their spending on capital from their profits before paying taxes Such a policy would effectively lower the price of capital, causing firms to substitute capital for other factors of production and increasing the demand for capital The repeal of an investment tax credit would lead to a decrease in the demand for capital The Market for Loanable Funds When a firm decides to expand its capital stock, it can finance its purchase of capital in several ways It might already have the funds on hand It can also raise funds by selling shares of stock, as we discussed in a previous chapter When a firm sells stock, it is selling shares of ownership of the firm It can borrow the funds for the capital from a bank Another option is to issue and sell its own bonds A bond is a promise to pay back a certain amount at a certain time When a firm borrows from a bank or sells bonds, of course, it accepts a liability—it must make interest payments to the bank or the owners of its bonds as they come due Regardless of the method of financing chosen, a critical factor in the firm’s decision on whether to acquire and hold capital and on how to finance the capital is the interest rate The role of the interest rate is obvious when the Attributed to Libby Rittenberg and Timothy Tregarthen Saylor URL: http://www.saylor.org/books/ Saylor.org 697