Llad Phillips1 Introduction to Economics Macroeconomics The US Economy

Llad Phillips2 Questions About the News n What is the economic significance of the following story in today’s business section of the LA Times?

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4 Questions About Your Reading n What do we mean by specialization? n What is comparative advantage? n What is a factor market? n What is circular flow? Chapter 3

Llad Phillips5 Households as Sellers and Buyers n In labor markets, households sell their labor to firms for wages. About 75% of income is earned by households.

Llad Phillips6 The Circular Flow Diagram The circular flow diagram is a diagram showing the flow of money and goods between markets.The circular flow diagram is a diagram showing the flow of money and goods between markets.

Llad Phillips7 Questions about your reading n What are the functions of government?

Llad Phillips8 Government in a Market Economy n The government has five general responsibilities in a market-based economy: Providing goods and services. Providing goods and services. Redistributing income. Redistributing income. Taxation. Taxation. Regulation of business practices. Regulation of business practices. Trade policy. Trade policy.

Llad Phillips9 Percentage of Government Spending on Various Programs

Tax Rates in Different Nations

Llad Phillips11 Questions About Your Reading n What is the law of demand? Chapter 4

The Individual Demand Curve and the Law of Demand n The individual demand curve shows the relationship between the price of a good and the quantity that a single consumer is willing to buy, or quantity demanded. The law of demand states that the higher the price, the smaller the quantity demanded, ceteris paribus (everything else held fixed).The law of demand states that the higher the price, the smaller the quantity demanded, ceteris paribus (everything else held fixed).

Llad Phillips13 Summary of Part I: Personal Finance Advice

Llad Phillips14 Summary of Personal Finance Life Span Learn EarnChoice Spend Save ?%

Llad Phillips15 SaveInvest & Build Equity Housing Financial, Including cash reserve Choice: What to Build Equity In?

Llad Phillips16 Who Wants to be a Millionaire? One Time Investment 11% ( we hope) 3 M Treasury 1.66% 0% Save 6% of Wealth Per Year & Invest Stocks +  Savings : 17% 5 Y Treasury 3.14% +  Savings: 9.14% Mattress +  Savings: 6%

Llad Phillips17 Your Stocks Market Indices The Economy corporate earnings(profits) Index of Leading Economic Indicators Gross Domestic Product Unemployment Rate

Llad Phillips18 Outline: Lecture Seven n Two major types of policy u fiscal policy: spending and taxation u monetary policy: the goals are low unemployment and low inflation. What are the tools? n Keynesian Models of the Economy u two-legged stool model u three-legged stool model n Inflation

Llad Phillips19 Review: lecture 6 n Keynesian “ Two - Legged Stool” Model u a weakness of the economy in the 1930’s

Llad Phillips20 National Economy Spending The Stool and Two Legs Total Spending Consumers Businesses

Llad Phillips21 Expenditure Perspective n Consumption spending by households, C n Investment spending by firms, I n GDP = C + I

Llad Phillips22 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 Phillips23 Autonomous Investment Investment, I Income, Y I

Llad Phillips24 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 Y* I* C* GDP*

Llad Phillips25 Consumption, C Investment, I GDP Income, Y autonomous consumption, C 0 Gross Domestic Product Equals Consumption Plus Investment GDP = C + I

Llad Phillips26 : Chapter Twenty n Conceptual Framework: Circular Flow Firms Households IncomeLabor Firms Households Supply Goods Demand Goods Income PerspectiveExpenditure Perspective Y= GDP

Llad Phillips27 Squares with Equal Sides and 45 degree Lines Income, Y Y1Y1 Y1Y Y = Y

Llad Phillips28 Consumption, C Investment, I GDP National Income, Y GDP = C + I 45 0 GDP = Y Income = expenditure I.e. Y = GDP Total Expenditure GDP Line Aggregate Expenditure

Llad Phillips29 Consumption, C Investment, I GDP Income, Y autonomous consumption, C 0 Economy in 2001: a decline in I leads to a decline in GDP C = C 0 + mpc* Y I GDP = C + I 1st

Llad Phillips30 Consumption, C Investment, I GDP National Income, Y GDP = C + I 45 0 GDP = Y Income = expenditure I.e. Y = GDP Total Expenditure GDP Line Aggregate Expenditure Unemployment Rate Oct = 3.9% Boom

Llad Phillips31 Consumption, C Investment, I GDP National Income, Y GDP = C + I 45 0 GDP = Y Income = expenditure I.e. Y = GDP Total Expenditure GDP Line Aggregate Expenditure Unemployment Rate Oct = 3.9% Bust Unemployment Rate Sept 2001 = 4.9 %

Llad Phillips33 Lecture 7 n Keynesian “Three Legged Stool Model” u federal government spending as a stabilizer

Llad Phillips34 National Economy Spending The Stool and Three Legs Total Spending Consumers BusinessesGovernment

Llad Phillips35 Consumption, C Investment, I GDP National Income, Y GDP = C + I +G 45 0 GDP = Y Income = expenditure I.e. Y = GDP Total Expenditure GDP Line Aggregate Expenditure Government, G

Llad Phillips36 Consumption, C Investment, I GDP National Income, Y GDP = C + I +G 45 0 GDP = Y Income = expenditure I.e. Y = GDP Total Expenditure GDP Line Aggregate Expenditure Unemployment Rate Oct = 3.9% Bust Unemployment Rate Sept 2001 = 4.9 %

Llad Phillips37 Unemployment Rate: unemployed/ (employed + unemployed) Unemployment Rate: unemployed/ (labor force)

Llad Phillips38 In the Great Depression n We did not have the sea anchor (third stool leg) of federal government spending to stabilize the economy

Llad Phillips39 federal government was 1.6%, while state & local government was 7.3%

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Llad Phillips41 Keynesian Fiscal Policy Option

Llad Phillips42 Why was Expenditure Too Low to Support Full Employment? n Consumption had dropped because of fear n Investment had dropped because of fear

Llad Phillips43 Policy Option: Reassure the Public “The only thing we have to fear is fear itself” Franklin Delano Roosevelt

Llad Phillips44 Fiscal Policy Option in 2001 n Use Federal Government Spending to Make up for the Shortfall in Consumption and Investment u prime the pump

Llad Phillips45 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 GDP = C+ I+G

Llad Phillips46 Are we missing any policy options? n Keynesian model and using more government spending during downturns is called fiscal policy n Federal Reserve conducts monetary policy

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Llad Phillips48 Federal Reserve Policy Goals n Full employment n stable prices (low inflation)

Llad Phillips49 Inflation Lecture 5

Llad Phillips50 What is the current rate of inflation? - Lab 4, Ch.21, Internet Exercises, “Inflation in the US”, Bureau of Labor Statistics, 0.3% for August, Year to date: =1.7% Source:

Llad Phillips51 Inflation: % rate of increase of CPI n 100*[CPI(August) - CPI(July)]/CPI(July) n What is the Consumer Price Index? n What is a price Index?

Llad Phillips52 Assigned reading n O’Sullivan and Sheffrin and Lab Four u Ch. 21 “Unemployment and Inflation” u What is the Consumer Price Index? u What is its purpose? u What effect could a higher inflation rate have on the US economy?

Llad Phillips53 Consumer Price Index n Prices of a Market Basket of Goods and Services n Index of the Cost of Living u but it leaves out public goods like safety and clean air which are hard to price n Based on a Monthly Survey of Prices by the Bureau of Labor Statistics(BLS) and the expenditure pattern (or mix of goods) of a sample of households. n Lab Four: Internet Exercises, “Inflation in the US, BLS and Consumer Price Info

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Llad Phillips55 Consumer Price Index: CPI n prepared by the Bureau of Labor Statistics, BLS, US Dept. of Labor, USDOL n =100 n weights for urban consumers, 10,000 families in the survey u housing = 42.6% u transportation = 18.7% u food & beverages = 17.8% u apparel & upkeep = 6.5% u other goods & services = 5.1% u medical care = 4.8% u entertainment = 4.4%

Llad Phillips56 What Impact Could a Rising Inflation Rate Have on US Economy? n Federal Reserve Bank of the US may raise short term interest rates to combat inflation n Raising interest rates could discourage consumers from purchasing durable goods, house, and cars n Raising interest rates could discourage business from borrowing to invest in new equipment and expansion n Prospect of higher interest rates affects stock market

Llad Phillips57 Economic Policy on a Knife Edge n If Federal Reserve raises interest rates to slow down the risk of inflation, it slows consumption and investment, which needs to recover to end a recession n A decrease in investment spending could slow down the growth in worker productivity, which has been permitting rapid growth at low rates of inflation

Llad Phillips58 Impact of War on Prices

Llad Phillips60 Historical Cost of Living: Mass. n World War I & aftermath: inflation u rapid increases in 1917, 1918; peak in 1920 n twenties: price stability n early thirties: deflation n World War II: inflation

Llad Phillips61 Consumer Price Index, Last Ten Years/ 1948-

Llad Phillips62 Inflation Rate: CPI

Llad Phillips63 Summary-Vocabulary-Concepts n national income n circular flow economy n value added n gross domestic product n consumption n gross private domestic investment n government expenditures n net exports n aggregate production function n nominal GDP n closed economy n John Maynard Keynes n aggregate expenditures n uncertainty n expectations n consumption function n autonomous consumption n marginal propensity to consume n equilibrium GDP n full employment GDP

Llad Phillips64 Inflation n Historical Cost of Living n Consumer Price Index n GDP Deflator n Real GDP and Growth of the Economy n Rate of Inflation n Impact of Inflation on You n Social Impact of Inflation n Inflation Forecast n Cause of Inflation

Llad Phillips65 Rate of Inflation n For example, the annual rate: u [P(t) - P(t-1)]/P(t-1) =  P(t)/P(t-1) F [CPI(1997) - CPI(1996)]/CPI(1996)

Llad Phillips66 GDP Deflator n Nominal GDP = GDP Deflator * Real GDP n Nominal GDP/Real GDP = GDP Deflator n Real GDP = Nominal GDP/GDP Deflator Nominal Value $ = Price * Quantity

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Llad Phillips69 GDP Deflator: History n early thirties: deflation n World War II: inflation n Korean War: inflation n fifties and sixties: price stability n Vietnam War: inflation u Lyndon Johnson: “guns and butter” n seventies: inflation u OPEC: energy prices n nineties: price stability

Llad Phillips70 Is the economy growing less rapidly? n Growth in real GDP over time

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