about Engineering Science Programme

Well, I think it’s prime time to write a blog post about the programme that I was engulfed in for the past 4.5 years. But then “mediocre”, a junior of mine wrote a pretty good summary blog post about it. While I’m still pondering about what to say, maybe you all should take a look @ what he’s wrote http://mediocre.wordpress.com/2010/12/25/nus-engineering-science-programme-revisited/

Why does prices increase when Investment increases?

Yup, that was the question that kept bugging me for the whole week. Somehow the way the lecturer explains Economics Principles is through the many many curves in the many many model, which sometimes have hidden assumptions.

Ok, it’s not really hidden but certain symbols like r_F or y* assume that it’s Full Employment or Equilibrium.

Ok, maybe I didn’t pay enough attention during the class, but oh well…

Ok, back to the topic. Due to the fact that we’re studying economic models, stuff like Aggregate Demand & Aggregate Supply (Prices vs Output/Income/GDP), Money Demand & Money Supply curves (Interest rate vs Money) are supposed to self-contain all the “truths” about what’s really happening out there.

Therefore, sometimes an explanation for

“Why does interest rate increases (restores) when the demand of money increases?”

is simply…..

“Oh, don’t you see, it’s clearly indicated on the graph.. see as M^d shifts to the right, the intersection point with M^s caused the interest rate to rise from r_1 back to r_F.”

how interest rate affects investment and ultimately price level
how interest rate affects investment and ultimately price level

Ya ya ya! I see it, thanks for pointing it out, I appreciate that, but wait….

“Why does it increase as in what really happened in the economy?”

all I’ve got is

“Oh, it’s really complicated, that’s why we are studying it in Macroeconomics.

“Ah…. I see.”

Enlightenment, not?

So, when I am stumped by “Why does prices increase when Investment increases?”, I was quite worried. I don’t think I’ll be satisfied if it’s another one of those “it’s too complicated” answer.

Fortunately, there’s a logical explanation as to why prices increases when investment increases. (Some parts of the next section involves minor-rephrasing copying from the Economics Text Book)

First, the hidden information that they assume you know when they point it out that investment has increased is that it has increased from an initial status of investment @ full-employment (potential output). {full employment here doesn’t mean ZERO unemployment, it means ZERO cyclical unemployment, there’s still unemployment in the form of structural [mismatch] and frictional [lag time] unemployment.}

As we’ve been told earlier, when investment increases, GDP increases, as GDP = C + I + G + NX. The “I” here is for investments. So as GDP increases, that means the economy is producing at a level above full employment.

What this means is that firms will find it increasingly difficult to hire and retain workers, and unemployment will be below its natural rate. Workers, on the other hand, will find it easy to get and change jobs.

Therefore, firms will raise their wages to attract workers and prevent them from leaving. As one firm raise its wage, other firms will have to raise their wages even higher to attract the workers that remain.

Wah…. wait wait wait… I asked about prices not wages, why you go and explain to me how wages increase? (but somehow it reminds me of the situation of CCA points in NUS, ok I’ve digressed)

Oh, still have more ar……. ok ok….

It just so happens that wages are the largest cost of production for most firms. Consequently, as their labor costs increase, they have no choice but to increase the prices of their products.

However, as prices rise, workers need higher nominal wages to maintain their real wages. (A good illustration of the real-nominal principle:

“What matters to people is the real value of money or income – its purchasing power – not the face value of money or income.”)

This process by which rising wages cause higher prices and higher prices feed higher wages is known as a wage-price spiral. It occurs when the economy is producing at a level of output that exceeds its potential.

Ohhh….. enlightenment….. ::Wunggggggmmmmmmm::

(ok this part onwards is entirely mine)

The more I delve into Economics, the more I feel like I’m part of a LONG RUN experiment. It’s like the many things that happens around you, happens above you without you knowing that it has happened. I’m sure not many people realize that governments, central banks, economist have been experimenting with different Fiscal Policies, Monetary Policies, sometimes Keynes, sometimes Friedman, balancing between Long Run and Short Run, making sure there’s no inflation but at the same time wants GDP to increase, etc etc etc…. Just so that I can have a bowl of wanton mee at $2 dollars when I’m hungry.

Macroeconomics is like one LARGE SCALE experiment where the subject appears to be the whole human population.

Scary eh?

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