1. Llad Phillips1 Introduction to Economics Elements of Personal Finance

2. Llad Phillips2 3. Thursday, Oct. 3, Lecture Three: "Housing loans; demand for mortgage credit; determinants of personal income" Housing loans: interest and equity demand for mortgage credit Determinants of personal income tastes for leisure and income Reading Assignment: O’Sullivan and Sheffrin: Ch.3, “ Markets in the Global Economy” emphasis: comparative advantage and circular flow O’Sullivan and Sheffrin, Appendix to Ch. 7, " Consumer Choice Using Indifference Curves”, pp. 155-162 Internet Resource: http://www.mortgage101.comhttp://www.mortgage101.com

3. Llad Phillips3 Problems O & S Text p. 60: 2, 4, 5, 6 p. 162: 1, 2, 3

4. Llad Phillips4 Econ 109 Class Page n Econ Home Page: http://www.econ.ucsb.edu http://www.econ.ucsb.edu

5. Llad Phillips5 Announcements n E-mail addresses u Llad Phillips u Llad Phillips u Donghun Cho u Donghun Cho u Taeil Kang u Taeil Kang u Kirk Lesh u Kirk Lesh

6. Llad Phillips6 Concepts n Lecture: Assets, Liabilities, Net Worth n Lecture: Demand for Housing Loans n Lecture: The Importance of Saving n Lecture: Learning and Earning n Text: Markets, the Magic and the Mantra

7. Llad Phillips7 Markets and Government in the Global Economy Chapter 3

8. Llad Phillips8 Markets as a Social Institution n Adam Smith: The Wealth of Nations(1776) u argues for free markets and free exchange n Markets allocate resources so supply meets demand n If markets are competitive, then the value that the last consumer entering the market is willing to pay equals the additional cost of producing one more unit of the good u this is the magic of markets: efficiency n The political mantra is that markets solve all problems: false if there is monopoly power

9. Current Economic Events n Labor Dispute between the shipping association and the longshoremen u lockout u cost to the economy: $1 B per day n What is at stake?

10. Llad Phillips10 Major Trading Partners of the United States, 1999

11. Llad Phillips11 World Economy Japan Mexico European Union US Economy YOUMe Japan

12. Llad Phillips12 Part I: Wealth (Net Worth) and Debt n Personal Wealth u a million millionaires u ordering the population form the poorest fifth to the richest fifth by income and net worth u the home is the big ticket asset n Liabilities: credit card debt u consumer debt service as a % of personal disposable income (after taxes)

13. Llad Phillips13 Net Worth in 1995 Source: http://www.irs.gov

14. Llad Phillips14 Families: Average Income and Average Net Worth, 1995 Source: Consumer Federation of America

15. Llad Phillips15 Demographics and Per Capita Wealth

16. Llad Phillips16 A Household’s Home Is By Far the Most Frequent Asset http://www.census.gov/hhes/www/wealth/1995/wealth95.html.

17. Llad Phillips17 Net Worth = Assets -Liabilities

18. Llad Phillips18 Assets-Liabilities Statement

19. Llad Phillips19 http://research.stlouisfed.org/fred/data/business/cmdebt

20. Llad Phillips20 http://research.stlouisfed.org/fred/data/business/cdsp

21. Llad Phillips21 Credit Cards Have High Interest Rates On Average: 15-20% You pay 15 % to borrow and you get, currently, 1-2%, to lend

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24. Llad Phillips24 Planning Tools n Assets-Liabilities Statement u Assets Minus Liabilities = Net Worth F measure of wealth n Income-Expenditure Statement u Income Minus Expenditures = Saving F measure of change in wealth

25. Llad Phillips25 Part II: Housing Loans, Demand

26. Life Cycle Approach: Planning Age Nurturing High School Education CollegeWorkRetirement Education: Investment in Human Capital or Earning Power Accumulating Assets cars appliances furnishings --------------------- house financial assets Spending

27. Life Cycle Approach: The Planners Age InfancyAdolescence Young AdultAdultSenescence 100% 50% 0 % You Parents

28. Llad Phillips28 Strategies for Meeting Future Expenses n Buy a House u most valuable asset for most US households u commitment to monthly payment n Tax-Sheltered Savings Plans u commitment to monthly payment n Stocks and Bonds

29. Llad Phillips29 Buying a House n Positives u provides space u builds equity u interest is deductible n Negatives? u down payment requires saving for this goal u interest payments are front-loaded, equity growth delayed u opportunity cost of not investing in stocks

30. Llad Phillips30 2000

31. Llad Phillips31 Example for an $80,000 House n price: $80,000 n down payment: $20,000 n loan: $60,000 n interest rate: 10% n loan term: 25 years

32. Llad Phillips32 calculated using TKSOLVER Level Debt Service Module

33. Llad Phillips33 Slow Growth In Equity n Interest is front loaded n Start with $20,000 equity in example n After 10 years, gained about $10,000 equity n After 20 years, gained about $35,000 equity n Last 5 years, gain last $25,000 in equity u less interest payments for tax deductions u may not want to refinance, since you are paying off principal

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37. Llad Phillips37 Interest Cost n You may not care so much u if you are experiencing capital gains F i.e. the value of the house is rising

38. Llad Phillips38 1999

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40. Llad Phillips40 Demand for Housing Loans n You are more likely to buy a house if the mortgage rate is low u your behavior is sensitive to the national economy n More people will be buying houses and demanding mortgage credit if the mortgage rate is low n More people will be buying houses and demanding mortgages if their income is rising u they can afford a higher monthly payment and a lower loan term

41. Llad Phillips41 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % 7 %

42. Llad Phillips42 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % Higher Personal Income

43. Llad Phillips43 Quantity of Mortgage Credit  Mortgage Rate, Personal Income Expressing The Demand For Mortgage Credit Q = f(r, Y) rule of correspondence: if you know the mortgage rate, r, and if you know personal income, Y, then you can determine the demand for mortgage credit, Q 1. Words 2. Symbols 3. Pictures r Q

44. Llad Phillips44 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % 7 %

45. Llad Phillips45 The importance of saving n commitment u discipline n personal income u determinants n managing expenses u income-expense statement F budgeting

46. Llad Phillips46 Part III: Learning and Earning, the Human Capital Story n Stocks u assets u debts u net worth(wealth) n Flows u income u saving (this flow is the increase inyour wealth)

47. Llad Phillips47 Determinants of Personal Income The Life Cycle Model

48. Llad Phillips48 An Individual’s Life Cycle for a Socially Productive Life n Learning over the life cycle n Accumulating earning power or human capital n Earnings depend upon u ability u knowledge u work experience

49. Llad Phillips49 Productive Life Cycle Social Institution Family - PreSchool - School - College - Job - Retirement Function Learning: Accum. Human Capital - Earning - Spending Age Line 0 4 6 18 23 65

50. Llad Phillips50 Accumulating Human Capital InflowOutflow Stock

51. Llad Phillips51 Accumulating Human Capital Stock Inflow + - Outflow Net Inflow

52. Llad Phillips52 Accumulating Human Capital Human Capital Learning + - Depreciation Investment Human Capital: An Asset Like a Car or a House: It Depreciates

53. Llad Phillips53 Allocation of Your Time Human Capital Build Capital by Learning Use Capital for Earning

54. Llad Phillips54 Time Endowment 24 hours

55. Llad Phillips55 24 hours0 hours Leisure (learning)

56. Llad Phillips56 Allocation of Your Time Human Capital Build Capital by Learning Use Capital for Earning

57. Llad Phillips57 24 hours0 hours Leisure (learning) Earnings $480 Opportunities for trading leisure for earnings (income) at a rate, $20 per hour, the market wage, determined by your stock of human capital(step one of the paradigm: describing the alternatives for choice) $ 0

58. Llad Phillips58 Salaries by Education Level, CA Full Time* Workers *Full Time: >35 hrs/wk, >48 wks/yr.; Source: LA Times, 1-10-93

59. Llad Phillips59 The Rich Get Richer and the Poor Get Poorer n Why does poverty persist in an affluent country like the US?

60. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 $240 dropout college grad Comparative market wages as determined by accumulated knowledge

61. Llad Phillips61 Choosing Between Learning and Earning n How much time for learning? n How much time for earning? n This choice, like all choices depends on your tastes u Do you want to earn and consume now? u Do you want to learn, earn more in the future, and consume more in the future?

62. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally(step two of the paradigm: valuing the alternatives for choice) Depicting your tastes graphically: iso-preference or indifference curves

63. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value Depicting your tastes graphically

64. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value The choice between leisure and earning now:picking the best alternative alternatives

65. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 high low value high value Optimum 15 hours of leisure $180 for 9 hrs of work Individual’s Supply of Labor

66. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work

67. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work $96 dropout is unwilling to work for $4/hr

68. Llad Phillips68 Why does the youth drop out? n may not like school n may receive bad or no advice u parents u counselors

69. Life Cycle Approach: The Planners Age InfancyAdolescence Young AdultAdultSenescence 100% 50% 0 % You Parents

70. Llad Phillips70 Participation in the Labor Force: Willing to look for work n If your market wage exceeds your reservation wage u college grad, @$20/hr, participates u the junior high dropout, @ $4/hr, does not n We assumed the college grad and the dropout both have the same values for income and leisure n Only their learning histories differ

71. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work $96 dropout is unwilling to work for $4/hr

72. Llad Phillips72 24 hours 0 hours $480 $ 0 high low value $96 Savings, $ from home Higher value

73. Llad Phillips73 Summary-Vocabulary-Concepts n median n demand curve n mortgage rate n personal income n mortgage credit n rule of correspondence n stock n inflow n outflow n time endowment n allocation of your time u learning(leisure) F earning in future u earning now n iso-preference curves n reservation wage