Step 16: Help Wanted

Full Employment (FE)

-FE equilibrium exists where AD intersects

Recessionary Gap

-Exists when equilibrium occurs below FE output
-AD shifts left and decreases

Inflationary Gap

-Exists when equilibrium occurs beyond FE output
-AD shifts right and increases

Interest rate 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

• How does business make investment decisions?
  -cost/benefit analysis
• How does business determine the benefits?
  -interest costs
• How does business determine the amount of investment they undertake?
  -if expected return > interest costs, invest
  -if expected return < interest costs, don't invest

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

• What's the difference?
  -nominal is the observable rate of interest. Real subtracts out inflation (π%) and is only ex post facto
• How do you compute the real interest rate (r%)?
  r%= i%(nominal interest rate) - π%(inflation)
• What determines the cost of an investment decision?
  -the real interest rate (r%)