Unit 3 - Nominal, Real, and Sticky Wages, & Investment Demand (2-22-16)

Nominal Wages vs. Real Wages

Nominal: amount of $ received by a worker per unit of time. Ex:) Paid by hour, by day, etc.

Real: amount of goods and services a worker can purchase with their nominal wages.

Sticky Wages

Sticky: where your nominal wage level is set according to an initial price level, and does not vary due to labor contracts or other restrictions.

What is investment?

Money spent or expeditures on:

• New plants (factories)
• Capital equipment (machinery)
• Technology (hardware and software)
• New homes
• Inventories (goods sold by producers)

Expected Rates of Return

1) How does business make investment decisions?

• Cost/Benefit analysis

2) How Does business determine the benefits?

• Expected rate of return

3) How does business count the cost?

• Interest costs

4) How does business determine the amount of investment they undertake?

-Compare expected rate of return to interest cost

• If expected return > interest cost, then invest
• If expected return < interest cost, then do not invest

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

Whats the difference?

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

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

• r% = i% - π%

What determines the cost of an investment decision

• The real interest rate (r%)

Shifts in Investment Demand (ID)

1) Cost of production

• Lower costs shift ID --->
• Higher costs shift ID <---

2) Business Taxes

• Lower business taxes shift ID --->
• Higher business taxes shift ID <---

3) Technological Change

• New technology shifts ID --->
• Lack of technology shifts ID <---

4) Stock of Capital

• If an economy is low on capital, then ID --->
• If economy has much, then ID <---

5) Expectations

• Positive expectations shifts ID --->
• Negative expectations shifts ID <---