Chapter 3

Question 1

what is 1+ nominal interest rate?

Answer 1

price of money today in terms of money next year. if you spend $1 more today you will (1 + i) less to spend next year

Question 2

what is the discount factor? how do we calculate?

Answer 2

1/ (1+it) is the price of money next year in temrs of money today. to get $1 next year save the discount factor today

Question 3

what is the real interest rate? how is it calculated?

Answer 3

measures how much more you can consume in the next period if you abstain from consuming it today
rt+1 approx = it - inflation t+1

Question 4

what is the relative price of goods today?

Answer 4

1 + rt+1 = pt/pt+1/(1 +it)
= 1+ it/ pt+1/pt
= 1 + it/ inflation t+1
approx = 1 +. it - inflation T+1

AKA Intertemporal relative price

Question 5

how much does investment constitute of AD?

Answer 5

20% in high income countries
share higher in fast growing countries
very volatile component

Question 6

how do we calculate change in capital stock?

Answer 6

K t+1 - Kt = It - depreciationKt

Question 7

why do firms invest?

Answer 7

It= K^d t+1 - Kt + depreciation Kt

1. increase capital stock
2. replace depreciated capital stock

Question 8

how is the desired capital stock chosen?

Answer 8

MPK / (1 + markup) - depreciation = rt+1

aka
real marginal production of capital - depreciation = real interest

Question 9

what is the condition for LR demand for capital?

Answer 9

Fk (K, EN^n)/ (1 + markup) - depreciation = r

Question 10

what is the effect of one extra unit of investment in year t on profits in year t+1?
what do the sum of these terms mean?

Answer 10

MPK t+1 x MR t+1 + (1 - depreciation Pt+1) - (1 + it) Pt

= 0 capital stock chosen optimally therefore profit maximising
The company should keep on investing until the increase in profit from an additional unit of capital is zero!

Question 11

what is the investment function?

Answer 11

I = Kd - K + depreciationK
= a/ (1+markup) x (r + depreciation) x Ye - (1-depreciation) K

Question 12

whats investment depend on?

Answer 12

a higher expected real interest rate has a negative effect on investment
a higher expected future demand increases investment
a higher capital stock at the beginning of the period reduces investment

Question 13

why is investment volatile? what is the accelerator effect?

Answer 13

net investment is driven by changes in the desired capital stock and the CS is largely related to production
relation between demand growth and investment is the accelerator effect