Download Lecture6 - UCSB Economics

Introduction to Economics
Macroeconomics
The US Economy
Llad Phillips
1
Questions About Your Reading
What is an economy?
 Are there different types of economies?
 What is a market?
 What did Adam Smith mean by the invisible
hand?

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Markets and the Invisible Hand
•
A market is an arrangement that
allows buyers and sellers to exchange
things: A buyer exchanges money for a
product; a seller exchanges a product
for money.
•
Adam Smith used the metaphor of the
invisible hand to explain how people
acting in their own self-interest may
actually promote the interest of society
Chapter 1
as a whole.
Question

What is the principle of diminishing
returns?
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PRINCIPLE of Diminishing
Returns
PRINCIPLE of Diminishing Returns
Suppose output is produced with two or more
inputs and we increase one input while
holding the other input or inputs fixed.
Beyond some point—called the point of
diminishing returns—output will increase at a
decreasing rate.
Can you think of an everyday example?
Chapter 2
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Question

What is macroeconomics?
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Macroeconomics
Macroeconomics is the study of the
nation’s economy as a whole.
Macroeconomic analysis can be used to:
 Understand how a national economy
works.
 Understand the grand debates over
economic policy.
 Make informed business decisions.
Chapter 1
Outline: Lecture Six, 2002
Vernon Smith wins Nobel
 National Income Accounting
 Great Depression of 1930’s

 How
bad can a downturn get?
 Birth of macroeconomics
 concepts
 tools:

national income accounting
Is it Happening Again?
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News in 2002
Why did the Dow go down ?
 Why is the Dow going up now?
 Are we going to have a double dip recession
coming?

 How
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could you figure that out?
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Part II Macroeconomics & US
Economy
Ch. 20 “Measuring a Nation’s Production
and Income”
 Ch. 21 “ Unemployment and Inflation

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Question

What do we mean by circular flow?
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: Chapter Twenty

Conceptual Framework: Circular Flow
Firms
Income
Firms
Labor
Supply
Goods
Demand
Goods
Households
Households
Income Perspective
Expenditure Perspective
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Income Perspective: Individual’s Supply of Labor
Earnings
$480
$180
for 9 hrs
of work
Lectures 2&3
low value
high
Optimum
high value
Leisure
(learning)
$0
0 hours
15 hours
of leisure
24 hours
Expenditure Perspective
Firms
Supply
Goods
Demand
For Goods
Consumption
Households
Households: Consumption of Goods and Services
Firms: Investment in Plant and Equipment
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Expenditure Perspective: Closed
Firms
Supply
Goods
Demand
Goods
Households
Government
Households: Consumption of Goods and Services
Firms: Investment in Plant and Equipment
Government: Expenditures on Goods and Services
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Expenditure Perspective: Open
Firms
Exports
(Sales)
Supply
Goods
Demand
Goods
Imports
(puchases)
Households
Government
Households: Consumption of Goods and Services
Firms: Investment in Plant and Equipment
Government: Purchase of Goods and Services
All Three: Exports - Imports = Net Exports
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What has been happening to
expenditure in the last year?

Sources of information
 US
Department of Commerce: Survey of
Current Business
 The Conference Board: Business Cycle
Indicators
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What is counted in GDP &
National Income?

The easy answer: what is easy to count.
 Strawberries,
cars, steel etc
 consumer and business income

What is left out? What is hard to measure.
 Underground
economy: barter
 crime
 household
production: cleaning, child care etc.
produced at home for no pay
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Lab Three: National Income and
Product Accounts (NIPA)-Ch. 20
Billions of Current $, Seasonally Adjusted at Annual Rates
01 III
01 IV
02 I
02 II
Consumption 6983.7
7099.9 7174.2
7254.7
Investment
1574.9
1500.7 1559.4
1588.0
Government
1851.7
1896.8 1939.5
1959.8
Net Exports
-312.6
-344.5
-425.6
Total: GDP
10097.7 10152.9 10313.1
-360.1
10376.9
GDP is Gross Domestic Product
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Pie Chart of $ 10.2 Trillion of GDP by Component, 01 II
consumption
investment
government
net exports
Buy more foreign goods than we sell abroad
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National Income and Product
Accounts (NIPA)-Ch. 20
Percent Change in Real (Constant $) GDP with Component
01 II 01 III 01 IV
02 I
02 II
Consumption 1.4
1.5
6.0
3.1
1.8
Investment
-17.6
-5.2
-17.3
18.2
7.9
Government
5.6
-1.1
10.5
5.6
1.4
Net Exports
-
Total: GDP
-1.6
-0.3
2.7
5.0
1.3
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Percent Change in Real(Constant $) GDP
Source: http://www.yardeni.com
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Dr. Ed Yardeni, Deutsch Bank Securities
http://www.yardeni.com
September 24, 1998
2000.Q1 2000.Q2 2000.Q3 2000.Q4
Real
GDP
4.8%
5.6%
4.2%
4.2%
Personal 7.6%
Cons.
3.1%
5.0%
3.8%
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How Bad Could It Get?

Great Depression
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The Great Depression
Impact on the US Economy
 Impact on Economic Thinking as a
Consequence
 What happens when the economy goes belly
up?
 Why does the economy go belly up?

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Unemployed Persons, Millions, 1929-1997
.
14
1933 trough
1982 trough
12
1938 trough
1991 trough
8
6
4
2
1945 trough
Year
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97
93
89
85
81
77
73
69
65
61
57
53
49
45
41
37
33
0
29
Millions
10
Personal Consumption Expenditures, Billions of '92 $
.
5000
1997
4500
4000
3000
2500
2000
1500
1929
1000
500
Year
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97
93
89
85
81
77
73
69
65
61
57
53
49
45
41
37
33
0
29
Billions
3500
Personal Consumption Expenditures, Billions of '92 $
.
10000
1000
1929
Year
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97
93
89
85
81
77
73
69
65
61
57
53
49
45
41
37
33
100
29
Billions
1997
Why does consumption fall by
20% between 1929 and 1933?
income has fallen and a large fraction of
people are unemployed
 times are bad, sentiment and expectations
are low, and people save for a rainy day if
they can
 wealth has decreased

 for
example, the stock market crash of 1929
decreased the wealth of investors in stocks, and
decreased consumption out of wealth
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Gross Private Domestic Investment, Millions 92 $ .
1400
1200
800
1991 trough
600
1982 trough
400
1933 trough
200
Year
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30
97
93
89
85
81
77
73
69
65
61
57
53
49
45
41
37
33
0
29
Millions
1000
Why does investment fall from
$92.4 B in’29 to $9.9 B in ‘32?

Not only are many people idle, so is much
of plant and equipment
 with
existing capital redundant, there is less
urgency to invest in new equipment
times are bad, consumers are not buying,
and businesses are failing, so business
sentiment and expectations are low
 if there is any cash flow, businesses may
decide to keep it as cash reserve against the
unexpected
event
rather
than
invest
it
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
Gross Domestic Product Components
in 1929 . .
net exports
0%
investment
16%
government
9%
federal government was 1.6%, while
state & local government was 7.3%
consumption
75%
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What were the policy options in 1933?
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Were consumers & firms afraid to spend?
Consumers
?$
Fear
Firms
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?$
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Impact of the Great Depression on
Economic Thought
The conventional wisdom at that time was to wait,
and the economy would recover
 The Englishman John Maynard Keynes was not
only a great economist but was aware of the
political danger the depression posed to capitalism
 he realized that it would be difficult to convince
consumers and businesses to spend more in the
depths of a recession
 he emphasized the importance of uncertainty
and expectations on behavior
 he stressed an aggregate expenditures
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perspective and a role for government spending

A Simple Keynesian model

The aggregate demand emphasis
 for
simplicity, ignore net exports and government
expenditure, small in ‘29

Aggregate expenditures, GDP, equals
consumption, C, plus investment, I
 GDP =


C+I
National Income, Y, equals consumption, C, plus
savings, S
In Equilibrium, Aggregate Expenditures, GDP
equals National Income, Y
 GDP = Y
 so
C+I=C+S
 and,
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in equilibrium, savings equals investment
36
: Chapter Twenty

Conceptual Framework: Circular Flow
Firms
Income
Firms
Labor
Supply
Goods
Demand
Goods
Households
Households
Income Perspective
Expenditure Perspective
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The Consumption Function
consumption, C
autonomous
consumption, C0
C = C0 + mpc* Y
the slope of the consumption function,
the marginal compensity to consume,
mpc, is the increase in consumption
per $ increase in income
Income, Y
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Autonomous Investment
Investment, I
I
Income, Y
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Gross Domestic Product Equals Consumption Plus Investment
Consumption, C
Investment, I
GDP
autonomous
consumption, C0
GDP = C + I
C = C0 + mpc* Y
I
Income, Y
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Squares with Equal Sides and 45 degree Lines
Y=Y
Income, Y
Y1
450
Y1
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Income, Y
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: Chapter Twenty

Conceptual Framework: Circular Flow
Firms
Income
Firms
Labor
Supply
Goods
Demand
Goods
Households
Households
Income Perspective
Expenditure Perspective
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
autonomous
consumption, C0
450
GDP=Y
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Income
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
autonomous
consumption, C0
I
450
Income
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
C = C0 + mpc* Y
autonomous
consumption, C0
I
450
Income
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
GDP = C + I
C = C0 + mpc* Y
autonomous
consumption, C0
I
450
GDP=Y
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Income
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What Happens if there is a Shock?
Using the Model of the Economy
Stock market crash of 1929
 or Attack on America, 9-11-2001?

 if
consumer confidence is shaken….
 If business confidence is shaken ….
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
GDP = C + I
C = C0 + mpc* Y
autonomous
consumption, C0
I
450
GDP=Y
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Income
48
Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
Consumption, C
Investment, I
GDP
GDP = C + I
C = C0 + mpc* Y
autonomous
consumption, C0
I
450
GDP=Y
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Income
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Equilibrium Level of Gross Domestic Product GDP=Y
GDP=Y
GDP = C + I
Consumption, C
Investment, I
GDP
C = C0 + mpc* Y
autonomous
consumption, C0
I
450
GDP=Y
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Income
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Then and Now: 1930’2 Vs. ‘02




High Unemployment
Low consumption
Low Investment
Little Federal
Spending
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



Low unemployment
High consumption
Low investment
Federal Spending
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Current Economic Events
% of Civilian Labor Force That Is Unemployed
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Summary-Vocabulary-Concepts







national income
circular flow economy
gross domestic product
consumption
gross private domestic
investment
government
expenditures
net exports
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




nominal GDP
closed economy
John Maynard Keynes
aggregate expenditures
uncertainty
expectations
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Summary of Part I:
Personal Finance Advice
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Summary of Personal Finance
Spend
Learn
Earn
Choice
?%
Save
Life Span
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Choice: What to Build Equity In?
Housing
Save
Invest & Build Equity
Financial,
Including
cash reserve
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Who Wants to be a Millionaire?
Stocks @ 11%
One Time
Investment
3 M Treasury Bills @ 2.22%
Mattress @ 0%
Save 6% of Wealth
Per Year & Invest
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Stocks +  Savings : 17%
5 Y Treasury Bonds @ 3.83%
+  Savings: 9.8%
Mattress +  Savings: 6%
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Your Stocks
Market
Indices
corporate earnings(profits)
The Economy
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Index of Leading Economic Indicators
Gross Domestic Product
Unemployment Rate
58
Unemployment Rate
Source: http://www.yardeni.com
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Index of Consumer Confidence
Source: http://www.yardeni.com
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Index of Leading Economic Indicators
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Source: http://www.yardeni.com
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The Size of the Economy:Gross Domestic Product in $B
Source: http://www.yardeni.com
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