ECO209Y5 Lecture Notes - Lecture 8: Real Interest Rate, Real Wages, Budget Constraint
Document Summary
Lecture #8 real intertemporal model with investment. Capital is an important input in the production process. Expenditure on capital consists of using some of the goods produced today in order to increase capacity to produce more tomorrow (tradeoff between profits today and tomorrow) Lives for 2 periods (tradeoff for today vs. tomorrow) Time endownment, h per period allocated to work and l, leisure. They"ll earn wage in each period w, w1. Given wages, taxes, and interest, consumer chooses l, l1, c, c1. Period 1 budget constraint c + sp = w(h-l) + profit t. Period 2 budget constraing c1 = w1(h-l1) + profit1 t1 + (1+r)sp. Consumer interacts with firm in period 1 in two ways: Current real wage w income effect vs sub effect. Real interest rate r increase in r means saving is more profitable, sub effect outweighs income effect so increase in r increases current labour supply.
