Full Employment – February 17, 2015

·         Full employment equilibrium exists where AD intersects SRAS and LRAS at the same point

Recessionary Gap

·         A recessionary Gap exists when equilibrium occurs below full employment output

·         Any time you are in a recession or in a recessionary gap, AD is shifting to the left which means it is decreasing

Inflationary Gap

·         An inflationary gap exists when equilibrium occurs beyond full employment output.

·         AD will shift to the right which shows an increase

Changes (Triangle) In AD

·         AD = Aggregate Demand

·         Pi symbol and Percentage = Inflation

·         u and Percent = unemployment

Investment

·         Investments are money spent or expenditures on:

o   New Plants (factories)

o   Capital equipment (machinery)

o   Technology (hardware & software)

o   New Homes

o   Inventories (goods sold by producers)

Expected Rates of Return

·         How does businesses make investment decisions?

o   Cost/Benefit Analysis

·         How does business determine the benefits?

o   Expected rate of return

·         How does business count the cost?

o   Interest costs

·         Hoe does business determine the amount of investment they undertake?

o   Compare expected rate of return to interest costs

§  If expected return > interest cost, then invest

§  If the expected return < interest cost, then do not invest

Real (r%) v. Nominal (i%)

·         What’s the difference?

o   Nominal is observable rate of interest. Real subtracts out inflation (pi%) and is only known ex post facto.

·         How do you compute the real interest rate (r%)?

o   r% = i% - pi%

·         What then, determines the cost of an investment decision?

o   The real interest rate (r%)

Investment Demand Curve (ID)

·         What is the shape of the Investment demand curve?

o   Downward sloping

·         Why?

o   When interest rates are high, fewer investments are profitable; when interest rates are low, more investments are profitable