Unit 3

2-21-17

Interest Rates and Investment Demand

• Investment
• Money spent or expenditures on:
• new plants (factories)
• capital equipment(machinery) 
• technology(hardware and software)
• new homes
• inventories(goods sold by producers)
• Expected Rates of Return
• cost/ benefit analysis - how business make investment
• how business count cost?
• invest cost
• How business determine amount of investment they undertake
• if expected return > interest cost, then invest
• if expected return < interest cost, then do not invest 
•  Real(R%) vs.Nominal(I%)
• How you compute real interest rate (R%)?
• r%= i% - π%
• nominal is observable rate of invest, real subtract out inflation ( π%) and is only known ex post factor
• what determines cost of investment decision?
• real interest rate (R%)
• Investment(ID) Demand curve shifts in (ID)
• shape of investment demand curve
• downward shaping
• Shifts in (ID)
• cost of production
• business taxes
• technology change
• stock of capital
• expectations

Aggregate supply

• Level of real GDP that firms produce at each price level (PL)
• long run vs. short run
• long run
• will be vertical
• period of time where input prices are completely flexible and adjust changes in price level
• level of real GDP supplied is independent at price level
• short run
• period where input prices sticky and do not adjust to changes in price levellevel of RGDP supplied directly related to price lvl
• Long run aggregate supply (LRAS)
• Yf is full employment
• bc inut prices are sticky SRAS is upward sloping
• Short run aggregate supply(SRAS)
• SRAS increase a shift to the right
• SRAS decrease a shift to the left 
• Per unit production cost= total input cost/ total output
• Determinate of SRAS
• Input price, productivity legal institutional environment
• Input
• Domestic resources prices
• wage(78% of business costs)
• price of capital  
• raw material (commodity prices)
• foreign resources price
• strong $- lower foreign resources prices
• weak= higher foreign resource prices
• Market Power
• monopolies and cartel that control resources control rice of those resources
• increase in resource prices = SRAS<-----
• decrease in resources prices= SRAS------>
• Productivity
• total output/total input
• more productivity = lower unit production cost = SRAS ----->
• lower productivity = higher unit production cost = SRAS<-----
• legal institution environment
• Taxes and subsides
• taxes ($ to govt) to business reduce per unit production cost=  SRAS <---
• subsides ($ to govt) on business reduce per unit production cost = SRAS--->
• govt regulation creates a cost of compliance= SRAS----->
• Deregulation reduces compliance cost = SRAS ---->