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Retail Sales (Measures changes in Consumer Spending Patterns) Web: www.census.gov/svsd/www/advtable.html Economic Indicator 3 Large revisions with annual changes in March Retail sales represents 1/3 of consumer spending, PCE, which makes up 70% of the economy Census bureau surveys 5000 retailers 3 days after month end for their latest sales numbers. Retail sales represent spending on goods only, not services – air travel, medical care, dental care, haircuts, insurance, movies, etc. – which represent 2/3 of personal expenditures. Measured in nominal/current dollars PtYt (not inflation adjusted) so don’t know if change is due to change in prices, change in volume or both. But economic performance is based on real growth rates (volume effect). So subtract percentage change in consumer price index to get good approximation of real percentage change in sales. Retail sales = Total sales receipts – returned merchandise – rebates – sales tax – excise tax – finance charges. Adjusted for seasonal variations (holidays, winter, etc.) Use a 3-month moving average to get more accurate sense of underlying trend. Strong correlation between change real retail sales and real GDP (DGDP/GDP)Et+1 = F [PCE = f (retail sales)] Subtract out the large (25%) but volatile motor vehicle category to better track underlying consumer spending trend. Watch for changes in gas prices which can change retail sales. PGas => retail sales but non-gas retail sales D(PY) = DPY1 + DYP1 + DPDY D(PY) = DPY1 + DYP1 + DPDY P1Y1 P1Y1 P1Y1 P1Y1 D(PY) = DP + DY + 0 P1Y1 P1 Y1 if DP and DY are small DY = D(PY) – DP Y1 P1Y1 P1 -------------------------------------------------------------------------------------------------------------------------Market Analysis Bonds: retail sales => DY/Y => DP/P => DBonds => iBonds Stocks: retail sales => revenues => profits => PStocks Many goods are imported => demand for euros/supply of dollars => P$ Dollar: income => imports => retail sales and trade deficit Retail Sales (excluding autos) (year over year % change) 12 12 11 11 10 10 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 -11996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -1 -2 -2 -3 -3 -4 -4 -5 -5 -6 -6 -7 -7 -8 -8 -9 -9 -10 -10 Chapter 1: The Essence of Economics Limited Resources => Limited Goods/Services < Unlimited Desires Scarcity/Constraints Outputs Decreasing Marginal Product => Increasing Marginal Cost => Upward Sloping Supply Curve Y Production Function,… y = f (x),….technology X Inputs / Resources / Factors of Production Scarcity The situation in which unlimited wants exceed the limited resources available to fulfill those wants. Trade-off The idea that because of scarcity, producing more of one good or service means producing less of another good or service. Scarcity => Tradeoffs => Choice Economics The study of the choices people make to attain their goals, given their scarce resources. Scarcity Limited Resources => Limited Goods/Services < Wants Poverty Limited Resources => Limited Goods/Services < Needs U.S Poverty Rate % Below Poverty Level (46 million in poverty) 16 15.1 15.1 14.8 15 14.5 14.3 14.2 14 13.8 13.7 13.5 13.4 13.0 13 13.3 12.8 13.2 12.7 12.7 12.6 12.5 12.1 11.9 12 12.3 12.5 11.7 11.3 11 10 9 8 87 88 89 90 91 Source: U.S Censu Bureau 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Production Function 4 Output, Y 3 2 1 0 0 1 2 3 4 5 Input, X 6 7 8 9 Production Function 4 Output, Y 3 2 1 0 0 1 2 3 4 5 Input, X 6 7 8 9 Practice Exercise Not to be handed in or graded 1. Assume the price of input x (labor) is equal to $1 and constant over varying levels of production. Assume the following production function; Y = X0.55. Draw the production relationship between input X and output Y. Create a table showing the marginal product for the first 5 units of X. Create a table showing the marginal cost of the first 3 units of Y. Graph the marginal cost curve. If 9 units of X are employed, calculate the average productivity of labor (Y/X). Assume now an improvement in technology leads to a new production function represented by Y = X0.65. Create a table showing the marginal cost of the first 3 units of Y. Graph the marginal cost curve. If 9 units of X are still employed, calculate the average productivity of labor (Y/X). 8 Principles of Economic Thinking 1. The use of scarce resources to produce a good is always costly. • • 2. Individuals behave rationally & economize • • • 3. Weigh cost & benefits of actions Maximize utility subject to a budget constraint Minimize costs subject to a technology and output Incentives Matter • • 4. Tradeoffs Opportunity cost Q. D. = F( P; Income, tastes, expectations,…..) Q. S. = F( P; technology,……) Focus on Marginal Changes • • • Marginal Analysis: Compare marginal costs to marginal benefits Optimal decisions are made on the margin,…spend a little more, save a little less vs. all or nothing An activity should be continued to the point where the marginal benefit is equal to the marginal cost. 8 Principles of Economic Thinking 5. Information is scarce => uncertainty is fact of life 6. Economic events => primary and secondary effects • • Law of unintended consequences Effective policy evaluation looks for indirect effects 7. Value of goods/services are subjective 8. The test of an economic theory is its ability to predict and explain events in the real world • • Positive analysis: Analysis concerned with what is. Normative analysis: Analysis concerned with what ought to be. – – Equity: The fair distribution of economic benefits. Equity Tradeoff: Increase equity => decrease efficiency 4 Pitfalls to avoid in Economic Thinking 1. Violation of Ceteris Paribus. • 2. Hold “other things equal” Good intentions do not guarantee desirable outcomes • • Unsound proposal => undesirable outcomes Political games 3. Fallacy of Composition • • Erroneous view that what is true for the individual is also true for the whole Micro vs Macro Economics 4. Association is not Causation • Logical fallacy: Post Hoc Ergo Propter Hoc The Scientific Method Applied to Social Sciences Economic Model – simplified version of reality. Economic models/theories make behavioral assumptions about economic agent motives. 5 Steps to Develop and Test an Economic Model 1. 2. 3. 4. 5. Decide on the assumptions to be used in developing the model. Formulate a testable hypothesis - is a statement that may be either correct or incorrect about an economic variable. Economic hypothesis are usually about a causal relationship; X => Y Use economic data to test hypothesis – analyze statistics on relevant economic variables to access the question, did X cause Y? Revise the model if it fails to explain well the economic data. Retain the revised model to help answer similar economic questions in the future. Interest Rates and Recessions 1988-2011 10 10 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Recession Baa Fed Funds 10-yr Treas Real Fed Funds (fed funds - core CPI) 12 10 4% = Recession causing level 8 6 4 2 0 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 -2 -4 0.10% - 2.0% = -1.9% -6 -8 8 10 12 Eight Problems when Determining Cause and Effect Relationships (causal inference) 1. 2. 3. 4. 5. 6. 7. 8. Has correlation (happening at the same time) been confused with causation. Common cause;. X and Y are effects of a common cause Z. DZ ==> DX DZ ======> DY Has temporality (chronological sequence) been confused with causality. This is the “post hoc fallacy”. Just because X preceded Y, doesn’t mean X caused Y. Are there significant multiple causes and effects. An effect might have multiple causes, so treating only one of them might not alter the presence of the effect. Have cause and effect been reversed; DX => DY,….or maybe DY => DX. Which way is the causal inference? The economy is always changing (hard to assume ceterus paribus) and it is virtually impossible to conduct controlled economic experiments. Third variable. There may be an omitted variable/factor causing the relationship. Are there intervening or counteracting causes. Both will reduce causal force brought to bear on the alleged effect. If statistical analysis confirms hypothesis, then accept economic model/theory. Rather than being “accepted”, hypothesis are considered “not rejected” . The Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade. Price Determined by Utility Maximization Marginal Benefit per unit Maximum willingness to pay S Determined by Profit Maximization Marginal Cost per unit Minimum willing to receive P* D Voluntary exchange The situation that occurs in markets when both the buyer and seller of a product are made better off by the transaction. Q* Quantity Demanded/Supplied Price The Market Economy & Resource Allocation S Determined by profit Maximization P* Determined by Utility Maximization D Q* Quantity Demanded/Supplied Market economy An economy in which the decisions of households and firms interacting in markets allocate economic resources. X Production Function Inputs Y Centrally planned economy An economy in which the government decides how economic resources will be allocated. Market Price S Productive efficiency The situation in which a good or service is produced at the lowest possible cost. P* D Q* Y Quantity Demanded/Supplied Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. 1st Theorem of Welfare Economics Markets => firm competition & voluntary exchange => Efficient Outcome Valve = Price # of threads = elasticity Quantity Supplied per year Inflow/Production Adam Smith’s Invisible Hand Water/Inventory/Stock Equilibrium Condition Inflow = Outflow QS = QD Determines Price/Valve turns Quantity demanded per year Outflow/Sales Personal Income, Spending & Savings (Gauge of Economic Activity) Web: www.bea.doc.gov/bea/newsreleases/rels.htm Revisions for several months after initial release. Annual revisions done every summer. Benchmarked every 5 years. Economic Indicator 4 Income + DDebt = Taxes + Debt Interest + Spending + Savings Wages & salaries 54% Proprietors income 9% Rental income 1% Dividend income 7% Interest income 10% Transfer payments 16% Other labor income 4% Durable goods Nondurable goods Services D Debt = borrowing future income for current consumption Debt Interest = interest payments on consumer loans to creditors (consumption expense). If Interest payments-to-DPI > 2.5%, then households may be experiencing financial stress and future spending may suffer. Spending = Personal Consumption Expenditures, PCE, make up over 70% of total GDP Savings = residual = Y – T – C – I = S – DD. Does not include capital gains on stocks, bonds, real estate. Spending is a function of income, DWealth and DP/P. Incomet => C t+1 If PStock = $1, then C = 3-6 cents If PHouse = $1, then C = 2-4 cents Real disposable personal income is a better portent of future consumer demand. Best measure of true consumer purchasing power. Dreal DPI foreshadows D spending Watch for precipitous changes in savings rates. Indicator of households’ concerns of financial future income/job security => savings rate => C optimism => savings rate => interest rates => investment Durable goods are expensive, often involve financing, and are sensitive to swings in the economy income/job stability => durable goods orders => production Excellent predictor of economic turning points durable good orders =>(6-12 months) recession onset durable good orders =>(1-2 months) recession ends/recovery begins The latest 3-month change in real PCE is a good indicator of quarterly GDP PCE Price index – Best measure of consumer inflation. Federal Reserve uses when setting interest rate policy. Typically 0.3 percentage points lower than CPI because it takes account of changing buying habits as relative prices change (substitution effect) ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ Market Analysis Bonds: Strong income/spending numbers => DY/Y => DP/P => Federal Reserve rates => DBonds=> iBonds Stocks: Strong income/spending numbers => DY/Y => profits => PStocks Dollar: Strong income/spending numbers => DY/Y => iBonds => DDollar => PDollar Personal Income & Consumption Expenditures [Year Over Year % Change] 10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 10 9 8 7 6 5 4 3 2 1 0 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 -1 -2 -3 -4 Recession Consumption Income -5 -6