Investment is an injection because money enters the economy that was previous not in the economy. Leakages and investments balance each other when the rate of return on investment compels sufficient investment. Thus, the interest rate determines the equilibrium point between savings and investment. Both households are more sensitive to changes in the real interest rate. A declining real interest rate will allow households to increase demand as their cost of borrowing decreases. For businesses, the real interest rate is less important because it impacts both the cost of borrowing and the expected rate of return on investment.
6. If there is increased labor supply, the following changes occur to the macroeconomic model for general equilibrium. This will allow more products to be produced, which but it should also decrease the cost of labor. Thus, the cost of producing goods will be decreased. The cost of capital should decrease in this equation because the returns on investment are lower. This allows greater production for a lower cost.
7. The supply and demand adjustments that bring the economy back to equilibrium do not occur quickly for sticky wages and sticky prices. These are wages and prices that are difficult to change. For example, wages can be sticky when they are determined by contracts, or when a floor such as a minimum wage is set. Prices are sticky to the extent that consumers are unwilling to accept increases or companies are unwilling to accept declines. The supply and demand adjustments necessary to bring an economy back to equilibrium should occur fairly quickly, but with sticky wages and prices these changes do not occur quickly. Thus, by the time the change occurs, the macroeconomic conditions...
As a result, the change in the wages and prices lags other macroeconomic changes, causing macroeconomic fluctuations and keeping the economy in a state of disequilibrium.
Bonus a. Technological innovation cannot occur in a perfectly competitive market because businesses have no incentive to do so. They are price takers, so investment in innovation will not result in higher profits. Perfect information means that consumers will be unwilling to pay more, so firms will only lower their profits by investing in innovation. In addition, once a new technology has been developed, the market is no longer in perfect competition as one firm will have broken the assumption about identical technology. The market will have moved to a state of monopolistic competition. Thus, by definition technological innovation cannot occur in a perfectly competitive market.
Bonus B. Policy is not a significant component of microeconomics because the field is based on individual consumer decisions. There is no incentive for government to develop policy goals for individual decisions. By its nature, macroeconomics deals with aggregate outcomes. Thus, it becomes a policy-driven discipline, simply for the fact that macroeconomic adjustments can impact aggregate outcomes for society. Historical experience impacts macroeconomic policy because it shows the types of policies that work best under given sets of conditions to achieve particular outcomes. History has shown that the set of specific goals identified by Stiglitz and Walsh is the most desirable set of long-term outcomes. Thus, policy is set with these objectives in mind, again based on historical experience with respect to successfully achieving these goals.
