Third Midterm is Thursday April 3.
It covers chapters 8, 9, 14, and 15.
Given we are omitting chapter 16 from this test,
cover Real Business Cycles
on it, contrary to what the syllabus says.
Practice quizzes in the Study Guide are a good way to prepare.
The following brief notes try to cover main points.
Investment and Saving.
Definitions of gross and net investment, depreciation [gross investment equals net investment
Saving supply, quantity of finance supplied increases with real interest rate; shifts right if income increases, left
if wealth increases.
Government surplus adds to finance available for investment, i.e. shifts saving supply curve rightward.
Investment demand slopes down; at lower interest rate, more investment projects will have returns greater than the opportunity cost
of investment [the real interest rate], so quantity of investment demanded is larger.
Investment demand shifts with expected
profits; if expected profits increase, investment demand shifts right.
Intersection of saving supply and investment demand gives the
equilibrium real interest rate.
For world as a whole, [X - M] is zero, so because uses of income equals income equals output equals
expenditure on output, C + S + T = C + I + G.
Rearranging, I = S + [T – G].
[T – G] is government budget surplus, government
saving, which shifts private saving supply right to give overall saving supply for world.
So government budget surplus world-wide
would lower real interest rate, finance more investment; deficit would raise real interest rate, ‘crowd-out’ some private investment.
Because of international flows of finance in response to small interest rate differentials [after risk adjustment], in any one country
this relationship does not have to hold.
In a single country, (X - M) is
zero, so C + S + T = C + I + G + (X – M), and
I = S + (T – G) + (M – X) – investment equals national saving [private saving S plus government saving (T - G)] plus foreign