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Recssion+of+2008-2009 - The Recession of 2008-2009(lets be...

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The Recession of 2008-2009 (let’s be optimistic) The goal of these notes is to give an understanding of the current recession based on a slight extension of the models we have already been working through. The extension basically involves adding enough additional apparatus to think about speculative motives for investment. Two-Sector Model Thus far we have tried to get by with the simplifying assumption that there is only one sector of production. Assuming that all goods are made in the same sector using the same production process allows all goods to have the same market price, P . Now let’s suppose that there are two sectors of production—one where consumption goods are produced and one where investment goods are produced. Let denote the price of capital or investment goods. Think of P as now some index of the prices of capital and consumption goods, as we did when discussing how the GDP Deflator was measured. We need a separate price of capital to talk about speculative investment because speculative investment occurs when you buy capital goods today (e.g. stocks—financial claims on physical capital used by corporations—or houses, nonresidential properties, etc.) with the idea that they might be worth more in the future even if the productivity of the asset does not increase. So, for a given MPK, you might also receive a capital gain —a rise in the relative price of the capital you own as time passes. The Return to Capital and Speculative Investment To purchase one unit of capital an investor must pay dollars today. To compute the expected return on this purchase we first consider the dollar value of the future output that one can produce with the capital, , where the e -superscript denotes the expected value of the overall price index next period. Next, we must consider the expected value of the capital itself next year. Accounting for depreciation, this value is . The annual rate of return is then the growth in future dollars relative to the dollars invested minus one, (1) . (Note that, as before, in equilibrium the expected return on physical capital must equal the rate of return on bonds, the nominal interest rate ( i ).) Let’s contrast this to our previous expression for the return to capital when there was only one sector of production,
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(2) . To most clearly see the difference between (1) and (2), consider the case where there was no
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Recssion+of+2008-2009 - The Recession of 2008-2009(lets be...

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