Llad Phillips1 Introduction to Economics Macroeconomics The US Economy

Llad Phillips2 Outline: Lexture Six News: Fed Cuts Interest Rates; Dow up 330 News: Fed Cuts Interest Rates; Dow up 330 National Income Accounting National Income Accounting The Great Depression The Great Depression

Llad Phillips3 News Why did the Fed cut interest rates? Why did the Fed cut interest rates? Why did the Dow go up 330? Why did the Dow go up 330? What effect will lower interest rates have on consumers? What effect will lower interest rates have on consumers? Is a recession coming? Is a recession coming?  How could you figure that out?

Llad Phillips4 Review Part II: Chapter Three Conceptual Framework: Circular Flow Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective

Llad Phillips5 Expenditure Perspective Firms Households Supply Goods Demand For Goods Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Consumption

Llad Phillips6 Expenditure Perspective: Closed Firms Households Supply Goods Demand Goods Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Government: Expenditures on Goods and Services Government

Llad Phillips7 Expenditure Perspective: Open Firms Households Supply Goods Demand Goods Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Government: Purchase of Goods and Services All Three: Exports - Imports = Net Exports Imports (puchases) Exports (Sales) Government

Llad Phillips8 What has been happening to expenditure in the last year? Sources of information Sources of information  US Department of Commerce: Survey of Current Business  The Conference Board: Business Cycle Indicators

Llad Phillips9 Lab Three: National Income and Product Accounts (NIPA)-Ch. 20 Billions of 1992 $ GDP is Gross Domestic Product

Llad Phillips10 Federal Reserve Bank: Philadelphia Economics/Survey of Professional Forecasters August 21, 1988

Llad Phillips11 Dr. Ed Yardeni, Deutsch Bank Securities 24, 1998

Llad Phillips12 Index of Consumer Confidence Last Recession ‘91 ‘70-’95 Lab One:

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Llad Phillips14 How Bad Could It Get? Great Depression Great Depression

Llad Phillips15 The Great Depression Impact on the US Economy Impact on the US Economy Impact on Economic Thinking as a Consequence Impact on Economic Thinking as a Consequence

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Llad Phillips17 Unemployment the number of unemployed persons increased from 1,550,000 in 1929 to 12,830,000 in 1933 the number of unemployed persons increased from 1,550,000 in 1929 to 12,830,000 in 1933 in 1933, 25% of those who wanted work, and were willing to look for work, could not find a job in 1933, 25% of those who wanted work, and were willing to look for work, could not find a job the depression of the thirties was nearly an order of magnitude worse than subsequent recessions the depression of the thirties was nearly an order of magnitude worse than subsequent recessions unemployment is cyclical, rising in bad times and falling in good times unemployment is cyclical, rising in bad times and falling in good times

Llad Phillips18 What happened in the early 30’s? An aggregate expenditures perspective An aggregate expenditures perspective  gross domestic product: its components  personal consumption expenditures  gross private domestic investment  exports minus imports = net exports  government expenditures

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Llad Phillips21 Why does consumption fall by 20% between 1929 and 1933? income has fallen and a large fraction of people are unemployed 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 times are bad, sentiment and expectations are low, and people save for a rainy day if they can wealth has decreased 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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Llad Phillips23 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 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 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 if there is any cash flow, businesses may decide to keep it as cash reserve against the unexpected event rather than invest it

Llad Phillips24 federal government was 1.6%, while state & local government was 7.3%

Llad Phillips25 What were the policy options in 1933?

Llad Phillips26 Were consumers & firms afraid to spend? Fear Consumers Firms ? $

Llad Phillips27 Impact of the Great Depression on Economic Thought The conventional wisdom at that time was to wait, and the economy would recover 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 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 perspective and a role for government spending

Llad Phillips28 A simple Keynesian model The aggregate demand emphasis The aggregate demand emphasis  for simplicity, ignore net exports and government expenditure, small in ‘29 Aggregate expenditures, GDP, equals consumption, C, plus investment, I Aggregate expenditures, GDP, equals consumption, C, plus investment, I  GDP = C + I National Income, Y, equals consumption, C, plus savings, S National Income, Y, equals consumption, C, plus savings, S In Equilibrium, Aggregate Expenditures, GDP equals National Income, Y In Equilibrium, Aggregate Expenditures, GDP equals National Income, Y  GDP = Y  so C + I = C + S  and, in equilibrium, savings equals investment

Llad Phillips29 A simple Keynesian Model The Consumption Function The Consumption Function  consumption expenditures has two components  autonomous consumption,C 0,that does not vary with income, for example, even if income was zero, there would be some spending out of wealth; shifts with fear  a component that increases with income but not $ for $, allowing for some savings Investment Investment  assume investment, I, is autonomous, i.e. does not vary with income, Y; shifts with fear

Llad Phillips30 consumption, C Income, Y autonomous consumption, C 0 The Consumption Function C = C 0 + mpc* Y the slope of the consumption function, the marginal compensity to consume, mpc, is the increase in consumption per $ increase in income

Llad Phillips31 Autonomous Investment Investment, I Income, Y I

Llad Phillips32 Consumption, C Investment, I GDP Income, Y autonomous consumption, C 0 Gross Domestic Product Equals Consumption Plus Investment C = C 0 + mpc* Y I GDP = C + I

Llad Phillips33 Squares with Equal Sides and 45 degree Lines Income, Y Y1Y1 Y1Y Y = Y

Llad Phillips34 Consumption, C Investment, I GDP Income autonomous consumption, C 0 Equilibrium Level of Gross Domestic Product GDP=Y C = C 0 + mpc* Y I GDP = C + I GDP=Y 45 0

Llad Phillips35 Consumption, C Investment, I GDP Income autonomous consumption, C 0 Equilibrium Level of Gross Domestic Product GDP=Y GDP = C + I GDP=Y 45 0

Llad Phillips36 Consumption, C Investment, I GDP Income, Y Less than Full Employment Equilibrium C = C 0 + mpc* Y I GDP = C + I 45 0 GDP = Y Y FE Full Employment Income

Llad Phillips37 Consumption, C Investment, I GDP Income, Y Less than Full Employment Equilibrium GDP = C + I 45 0 GDP = Y Y FE Full Employment Income

Llad Phillips38 Policy Option “The only thing we have to fear is fear itself” Franklin Delano Roosevelt

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Llad Phillips40 Summary-Vocabulary-Concepts national income national income circular flow economy circular flow economy value added value added gross domestic product gross domestic product consumption consumption gross private domestic investment gross private domestic investment government expenditures government expenditures net exports net exports aggregate production function aggregate production function nominal GDP nominal GDP closed economy closed economy John Maynard Keynes John Maynard Keynes aggregate expenditures aggregate expenditures uncertainty uncertainty expectations expectations consumption function consumption function autonomous consumption autonomous consumption marginal propensity to consume marginal propensity to consume equilibrium GDP equilibrium GDP full employment GDP full employment GDP

Llad Phillips41 Quiz Results Total # 138 Late 1 Absent 5 Score Grade Number 39-40A A A B B B C C C D D D F 1