Full Employment

Full employment equilibrium exists where AD intersects SRAS and LRAS at the same point

A recessionary gap exists when equilibrium occurs below full employment output
-any time you are in a recession AD will shift left which is decreasing

Inflationary gap: exists when equilibrium occurs beyond full employment output
-shifts to the right which increase

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?
-expected rate of return

How does business count the cost?
-interest costs

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%)
What's the difference?
-nominal is the observable rate of interest. Real subtracts inflation (pi%) and is only known ex post facto

How do you compute the real interest rate (r%)?
r% = i% - pi%

What then, determines the cost of an investment decision?
the real interest rate (r%)