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CH 04
4.2 INVESTMENT
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Investment *fluctuates sharply- corelated with busines cycles
desired capital stock - amt of capital which leads to max profit
-depends on Cost n Benifit of additional unit of capital
-benifit of investment is MPK(f)
user cost per each unit of capital K= real interest cost + depriciation
uc= rpk + dpk = (r+d)pk
----------------------------------------------*determination of desired capital stock
CH 04
4.3 Good market Equillibrium
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* real interest rate adjusts to bring goods market into equilibrium
Y= Cd + Id + G
Since, Desired Savings = Desired Investment
Sd = Id
therefore,
Sd = Y- Cd - G
-----------------------------------SAVING - INVESTMENT diagram
y- axis real interest rate
x- asis Sd and Id
equilibrium where Sd=Id
------------------------------sample table
real interest rate | Output Y | Cd | Id | G|
Desired National Saving | Aggregate Demand for Goods
Sd = Y- Cd -G
| Y= Cd + Id +G
desired absorbtion = Cd + Id + G
Net Exports NX = Y - (absorption)
Net foreign lending NX = Net foerign lending
Desired National Saving Since , Y= Cd + Id + G
is also => Y= Cd + Sd + G
therefore, Sd= Y- Cd - G
or simply , Sd= Id + NX
------------------------------------------------EFFECTS OF ECONOMIC SHOCKS
Anything that ^Sd relative to Id at a given world real interest rate , Increases the
Net foreign lending/ Current Account
^Sd ( ^Y , future output falls , or G falls)
Id decreases ( A fall in MPK , an Increase in Taxes )
-----------------Anything that ^Id relative to the Sd at given rw , decreases Net foreign lending /
Current Account
Sd falls ( Y falls , G increases)
Id^ ( An increase in MPKf , a decrease in taxes)
distance between the saving curve and investment curve on the the world real
interest rate line is CURRENT ACCOUNT SURPLUS
the shift in either saving/investment i.e from S to S1 or I to I1 is a result of change in
some factor which can be measure as a distance between the two points on the line
of world real interest rate.
----------------------------------------------5.4 Goods market equilibrium in LARGE OPEN ECONOMY
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- an economy large enough to affect the world real interest rate.
- world real interest rate moves to equlibrate desired international lending of one
country with the desired national borrowing by another.
or
- The equilibrium is determined such that a CA surplus of one country is *equal in
magnitude* to the CA deficit of another.
GRAPH
Home Country and Foreign country shares same world real interest rate.
the distance between Saving and investment curves in both home n foreign is equal
in magnitude (from x-axis)
The distance between the points on world real interest rate from S1 to Id shows the
CA surplus DECREASE.
------------------------------------------------CH 07 (1,2,3,4,5)
THE ASSET MARKET, MONEY AND PRICES
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7.1 WHAT IS MONEY ?
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Money : Assets that are widely used and accepted as payment
-----------------------------------------------FUNCTIONS OF MONEY
1. Medium of Exchange (- seperate transactions,
- less cost in time,
- allows specialization)
2. Unit of Account ( -Simplifies comparisons,
-countries with HIGH INFLATION may use
different unit of account, so they
constantly dont have to change prices)
3. Store of Value (- hold wealth, for small periods)
------------------------------------------------MEASURING MONEY
monetary aggregates
M1 : - currency and travellers checks held by public
- Demand deposits ( which pay no interest)
- Other checkable deposits ( which may pay interest)
*all components of M1 are used in making payments.
M2 : M1 + ( less moneylike assets)
- saving deposits
- small time deposits
- nonistitutional MMMFs balances
- money market demand assets MMDAs
------------------------------------------------MONEY SUPPLY (M)
money supply = money stock = amt of available money in the market
^M when c.b uses new printed money to buy financial assets from the public
Central bank can increase or decrease money supply through open market purchase
and sale called open market operations
------------------------------------------------7.2 PORTFOLIO ALLOCATIONS AND DEMAND FOR ASSETS
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1. Expected Return (returns not known in advance)
Md = P x L (Y, r+re)
Md/P = L(Y, i)
-----------------------------------------------DETERMINANTS OF Md
An increase in
Causes Md to
1.
2.
3.
4.
5.
Price
rise propostionally
Real income
rise less than proptionally
real interest rate
fall
expected infaltion
fall
nominal interest rate
on non monetray assets
fall
6. nominal interest rate
on MONEY
rise
7. wealth
RISE
( part of an increase of wealth might be money)
8. liquidity of alternative assets
fall
9. efficiency of payment technologies fall
------------------------------------------------ELASTICITIES OF MONEY DEMAND
Elasticity; % change in Md caused by 1 % change in some factor
1. Price Elasticity ( P )
(of Md is UNITARY , so Md is propotional to price level)
2. Income Elasticity ( Y )
- Positive and less than one:
(higher income increases money demand but less than
proptionaltity.)
3. Interest Elasticity
- Small and negitive : (higher ineterest rate on nonmonetary assets reduces
money demand slightly )
------------------------------------------------VELOCITY AND THE QUANITY THEORY OF MONEY
Velocity (V) how much money turns over each year
V = Nominal GDP/ Nominal Money Supply
V=PY/M
quantity theory of Money: Real money demand is propotional to real income
Md / P = k Y
Assumes that k constant is velocity
------------------------------------------------7.4 ASSET MARKET EQUILIBRIUM
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an aggregate asumption
All assets grouped in M1(currency n checkin accounts) and M2 (stocks and bonds)
M1 , interest rate im , supply fixed at M
M2 , interest rate i = r+ re , supply fied NM
*equlibrium occurs when Money Supply = Money demand
Md + NMd = Aggregate nominal wealth
M + NM = Aggregate Nominal wealth ( supply of assets )