Unit 3 cont...

February 22, 2016

Nominal Wages: Amount of money received by a worker per unit of time

Real Wage:  Amount of goods and services a worker can purchase with their nominal wage

Sticky Wages: Nominal wage level that is set according to an initial  price level and doesn't vary due to labor contracts or other restrictions

	Price	Wages	Employment Level	Implications
Recession (Keynesian range)	fixed	fixed	flexible	Output depends upon changes in the employment level
Intermediate	flexible	fixed	flexible	Output depends upon changes in price and the employment level
Inflation (Classical Range)	flexible	flexible	fixed	Output is independent of changes in price level

What is investment?

Money spent or expenditures on:

• New plants/ factories
• Capital equipment / machinery
• Technology / hardware & software
• New Homes
• Inventories / goods sold by producers
• 
  

Expected Rate of Return:

How does business make investment decisions?

• Cost/benefit analysis

How does business determine the benefits?

• Expected rate of return

 How does business count the cost?

• Interest costs

 How does business determine the amount of investment they undertake?

• Compare expected rate of return to interest cost

Expected Return > Interest Cost, then invest

Expected Return < Interest Cost, do not invest

Real Interest Rate (r%) vs. Nominal (i%) :

• Nominal is observable rate of interest
•  Real subtracts inflation (π %) and is only known ex post facto

Real interest rate 

• r%= i% - π%
• Real Interest Rate determines investment decision

Investment Demand Curve (ID):

What is the shape?

•  Downwards sloping
• when interest rates are high, fewer investments are profitable
•  when interest rates are low, more investments are profitable

Shifts in ID:

Cost of Production:

• Lower costs shift ID right➡️  
• Higher costs shift ID left⬅️

Business Taxes:

• Lower business taxes shift ID right ➡️  
• Higher business taxes shift ID left⬅️

Technological Change:

• New technology shifts ID right➡️  
• Lack of technological change shifts ID left⬅️

Stock of Capital:

• If an economy is low on capital ID shifts right➡️  
• If an economy is high on capital ID shifts left⬅️

Expectations:

• Positive expectations shift ID right➡️  
• Negative expectations shift ID left⬅️