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Marginal Product Of Capital, Efficient Equity Markets
Profit-maximizing firms should continue to invest in economic capital to the point where the marginal product of capital equals the marginal cost of financial capital. As such, the returns to shareholders on the right-hand side of the balance sheet should be justified by the returns generated by assets employed on the left-hand side. The author compares the net real after-tax marginal product of capital with returns on U.S. equities over the period 1950 to 2007. The results show that long-term returns on large cap U.S. equities are justified by the marginal product of capital.