by Robert P. Murphy

"Suppose the nominal interest rate is 10%. So you lend someone $100 today, and get paid back $110 next year. Ah, but in the meantime, 'prices' have risen by 3%. So, we say that the 'real' or 'inflation-adjusted' interest rate is actually only about 7%. More specifically, most economists would look at a basket of consumer goods to gauge the 'price level' and say that it has risen 3%.

So if you step back and consider, what we’re ultimately doing is figuring out how many more units of consumption goods people get, if they are willing to postpone consumption for a year." (05/12/14)

## How economists treat interest

by Robert P. Murphy

"Economists often make a distinction between an actual market price in a transaction, versus a 'hypothetical price' that we imagine must be the case in order to complete our model. For example, suppose we have a group of potential workers and potential employers, and that we know their preferences for leisure/wages and output/money. Every day we can compute what the market-clearing wage is. Now suppose that on a religious holiday, the market-clearing wage is $82/hour, at which price the total quantity supplied and demanded of labor is 0 hours. (Nobody wants to work on this very holy day, and the wage needs to be $82/hour in order to make no employer want to hire even a single hour of labor.) So it’s fine to academically say, 'The wage is $82/hour even though no wages are paid,' but on the other hand, in the real world we would have no way of actually knowing that." (05/14/14)

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