Llad Phillips1 Introduction to Economics Macroeconomics The US Economy

Llad Phillips2 Questions About Your Reading What is an economy? What is an economy? Are there different types of economies? Are there different types of economies? What is a market? What is a market? What did Adam Smith mean by the invisible hand? What did Adam Smith mean by the invisible hand?

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. 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 as a whole. 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 as a whole. Chapter 1

Llad Phillips4 Question What is the principle of diminishing returns? What is the principle of diminishing returns?

Llad Phillips5 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

Llad Phillips6 Question What is macroeconomics? What is macroeconomics?

Macroeconomics Macroeconomic analysis can be used to: Understand how a national economy works. Understand how a national economy works. Understand the grand debates over economic policy. Understand the grand debates over economic policy. Make informed business decisions. Make informed business decisions. Macroeconomics is the study of the nation’s economy as a whole. Chapter 1

Llad Phillips8 Outline: Lecture Six, 2002 Vernon Smith wins Nobel Vernon Smith wins Nobel National Income Accounting National Income Accounting Great Depression of 1930’s Great Depression of 1930’s  How bad can a downturn get?  Birth of macroeconomics  concepts  tools: national income accounting Is it Happening Again? Is it Happening Again?

Llad Phillips9 News in 2002 Why did the Dow go down ? Why did the Dow go down ? Why is the Dow going up now? Why is the Dow going up now? Are we going to have a double dip recession coming? Are we going to have a double dip recession coming?  How could you figure that out?

Llad Phillips10 Part II Macroeconomics & US Economy Ch. 20 “Measuring a Nation’s Production and Income” Ch. 20 “Measuring a Nation’s Production and Income” Ch. 21 “ Unemployment and Inflation Ch. 21 “ Unemployment and Inflation

Llad Phillips11 Question What do we mean by circular flow? What do we mean by circular flow?

Llad Phillips12 : Chapter Twenty Conceptual Framework: Circular Flow Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective

24 hours0 hours Leisure (learning) Earnings $480 $ 0 high low value high value Optimum 15 hours of leisure $180 for 9 hrs of work Income Perspective: Individual’s Supply of Labor Lectures 2&3

Llad Phillips14 Expenditure Perspective Firms Households Supply Goods Demand For Goods Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Consumption

Llad Phillips15 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 Phillips16 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 Phillips17 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 Phillips18 What is counted in GDP & National Income? The easy answer: what is easy to count. 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. 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

Llad Phillips19 Lab Three: National Income and Product Accounts (NIPA)-Ch. 20 Billions of Current $, Seasonally Adjusted at Annual Rates GDP is Gross Domestic Product

Llad Phillips20 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

Llad Phillips21 National Income and Product Accounts (NIPA)-Ch. 20 Percent Change in Real (Constant $) GDP with Component

Llad Phillips22 Percent Change in Real(Constant $) GDP Source:

Llad Phillips23 Dr. Ed Yardeni, Deutsch Bank Securities 24, 1998

Llad Phillips24 How Bad Could It Get? Great Depression Great Depression

Llad Phillips25 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 What happens when the economy goes belly up? What happens when the economy goes belly up? Why does the economy go belly up? Why does the economy go belly up?

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Llad Phillips29 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 Phillips31 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 Phillips32 federal government was 1.6%, while state & local government was 7.3%

Llad Phillips33 What were the policy options in 1933?

Llad Phillips34 Were consumers & firms afraid to spend? Fear Consumers Firms ? $

Llad Phillips35 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 Phillips36 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 Phillips37 : Chapter Twenty Conceptual Framework: Circular Flow Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective

Llad Phillips38 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 Phillips39 Autonomous Investment Investment, I Income, Y I

Llad Phillips40 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 Phillips41 Squares with Equal Sides and 45 degree Lines Income, Y Y1Y1 Y1Y Y = Y

Llad Phillips42 : Chapter Twenty Conceptual Framework: Circular Flow Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective

Llad Phillips43 Consumption, C Investment, I GDP Income autonomous consumption, C 0 Equilibrium Level of Gross Domestic Product GDP=Y GDP=Y 45 0

Llad Phillips44 Consumption, C Investment, I GDP Income autonomous consumption, C 0 Equilibrium Level of Gross Domestic Product GDP=Y I GDP=Y 45 0

Llad Phillips45 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=Y 45 0

Llad Phillips46 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 Phillips47 What Happens if there is a Shock? Using the Model of the Economy Stock market crash of 1929 Stock market crash of 1929 or Attack on America, ? or Attack on America, ?  if consumer confidence is shaken….  If business confidence is shaken ….

Llad Phillips48 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 Phillips49 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 Phillips50 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 Phillips51 Then and Now: 1930’2 Vs. ‘02 High Unemployment High Unemployment Low consumption Low consumption Low Investment Low Investment Little Federal Spending Little Federal Spending Low unemployment Low unemployment High consumption High consumption Low investment Low investment Federal Spending Federal Spending

Llad Phillips52 Current Economic Events % of Civilian Labor Force That Is Unemployed

Llad Phillips53 Summary-Vocabulary-Concepts national income national income circular flow economy circular flow economy gross domestic product gross domestic product consumption consumption gross private domestic investment gross private domestic investment government expenditures government expenditures net exports net exports nominal GDP nominal GDP closed economy closed economy John Maynard Keynes John Maynard Keynes aggregate expenditures aggregate expenditures uncertainty uncertainty expectations expectations

Llad Phillips54 Summary of Part I: Personal Finance Advice

Llad Phillips55 Summary of Personal Finance Life Span Learn EarnChoice Spend Save ?%

Llad Phillips56 SaveInvest & Build Equity Housing Financial, Including cash reserve Choice: What to Build Equity In?

Llad Phillips57 Who Wants to be a Millionaire? One Time Investment 11% 3 M Treasury 2.22% 0% Save 6% of Wealth Per Year & Invest Stocks +  Savings : 17% 5 Y Treasury 3.83% +  Savings: 9.8% Mattress +  Savings: 6%

Llad Phillips58 Your Stocks Market Indices The Economy corporate earnings(profits) Index of Leading Economic Indicators Gross Domestic Product Unemployment Rate

Llad Phillips59 Unemployment Rate Source:

Llad Phillips60 Index of Consumer Confidence Source:

Llad Phillips61 Index of Leading Economic Indicators Source:

Llad Phillips62 The Size of the Economy:Gross Domestic Product in $B Source: