Llad Phillips1 Introduction to Economics Macroeconomics The US Economy.

Llad Phillips 1

Introduction to EconomicsIntroduction to Economics

MacroeconomicsMacroeconomics

The US EconomyThe US Economy

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Outline: Lexture SixOutline: Lexture Six

News: Fed Cuts Interest Rates; Dow up 330News: Fed Cuts Interest Rates; Dow up 330 National Income AccountingNational Income Accounting The Great DepressionThe Great Depression

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NewsNews

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 What effect will lower interest rates have on

consumers?consumers? Is a recession coming?Is a recession coming?

How could How could youyou figure that out? figure that out?

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Review Part II: Chapter ThreeReview Part II: Chapter Three Conceptual Framework: Circular FlowConceptual Framework: Circular Flow

Firms

Households

Income Labor

Firms

Households

SupplyGoods

Demand Goods

Income Perspective Expenditure Perspective

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Expenditure PerspectiveExpenditure Perspective

Firms

Households

SupplyGoods

DemandFor Goods

Households: Consumption of Goods and ServicesFirms: Investment in Plant and Equipment

Consumption

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Expenditure Perspective: ClosedExpenditure Perspective: Closed

Firms

Households

SupplyGoods

Demand Goods

Households: Consumption of Goods and ServicesFirms: Investment in Plant and EquipmentGovernment: Expenditures on Goods and Services

Government

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Expenditure Perspective: OpenExpenditure Perspective: Open

Firms

Households

SupplyGoods

Demand Goods

Households: Consumption of Goods and ServicesFirms: Investment in Plant and EquipmentGovernment: Purchase of Goods and ServicesAll Three: Exports - Imports = Net Exports

Imports(puchases)

Exports(Sales)

Government

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What has been happening to expenditure in the last year?What has been happening to expenditure in the last year? Sources of informationSources of information

US Department of Commerce: US Department of Commerce: Survey of Survey of Current BusinessCurrent Business

The Conference Board: The Conference Board: Business Cycle Business Cycle IndicatorsIndicators

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Lab Three: National Income and Product Accounts (NIPA)-Ch. 20Lab Three: National Income and Product Accounts (NIPA)-Ch. 20

97 II 97 III 97 IV 98 I 98 II

Consumption 4872.7 4947.0 4981.0 5055.1 5130.2

Investment 1211.3 1215.8 1241.9 1321.8 1306.5

Government 1284.4 1288.9 1289.2 1283.0 1294.8

Net Exports -131.6 -142.4 -149.0 -198.5 -245.2

Total: GDP 7236.5 7311.2 7364.6 7464.7 7486.3

Billions of 1992 $

GDP is Gross Domestic Product

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Federal Reserve Bank: PhiladelphiaFederal Reserve Bank: Philadelphia

98 III 98 IV 99 I 99 II 99 III

GDPB 92$

7530.0 7587.0 7629.9 7668.8 7716.3

GDP%In-crease

2.1 3.1 2.3 2.1 2.5

NetExportsB $

-271.8 -280.0 -287.6 -289.7 -287.3

http://www.phil.frb.org/Economics/Survey of Professional ForecastersAugust 21, 1988

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Dr. Ed Yardeni, Deutsch Bank SecuritiesDr. Ed Yardeni, Deutsch Bank Securities

98I

98II

98III

98IV

99I

99II

99III

99IV

RealGDP% In-crease

5.5 1.8 3.0 2.5 2.2 1.5 0.0 -1.0

Consum-ption% In-crease

6.1 6.1 3.4 2.7 1.9 1.5 0.9 0.0

http://www.yardeni.com September 24, 1998

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Index of Consumer ConfidenceIndex of Consumer Confidence

Last Recession ‘91

‘70-’95

Lab One:http://www.mlinet.com/mle/econdata.htm

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Monthly Index of Consumer Confidence, 1985=100 .

0

20

40

60

80

100

120

140

96.0196.0396.0596.0796.0996.1197.0197.0397.0597.079.09

97.1198.0198.0398.0598.0798.09Date

Index

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How Bad Could It Get? How Bad Could It Get?

Great DepressionGreat Depression

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The Great DepressionThe Great Depression

Impact on the US EconomyImpact on the US Economy Impact on Economic Thinking as a Impact on Economic Thinking as a

ConsequenceConsequence

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Unemployed Persons, Millions, 1929-1997 .

1982 trough

1991 trough

1945 trough

1938 trough

1933 trough

0

2

4

6

8

10

12

14

29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97Year

Millions

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UnemploymentUnemployment the number of unemployed persons increased the number of unemployed persons increased

from 1,550,000 in 1929 to 12,830,000 in from 1,550,000 in 1929 to 12,830,000 in 19331933

in 1933, 25% of those who wanted work, and in 1933, 25% of those who wanted work, and were willing to look for work, could not find were willing to look for work, could not find a joba job

the depression of the thirties was nearly an the depression of the thirties was nearly an order of magnitude worse than subsequent order of magnitude worse than subsequent recessionsrecessions

unemployment is cyclical, rising in bad times unemployment is cyclical, rising in bad times and falling in good timesand falling in good times

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What happened in the early 30’s?What happened in the early 30’s? An aggregate expenditures perspectiveAn aggregate expenditures perspective

gross domestic product: its componentsgross domestic product: its components personal consumption expenditurespersonal consumption expenditures gross private domestic investmentgross private domestic investment exports minus imports = net exportsexports minus imports = net exports government expendituresgovernment expenditures

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Personal Consumption Expenditures, Billions of '92 $ .

1997

1929

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97Year

Billions

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Personal Consumption Expenditures, Billions of '92 $ .

1997

1929

100

1000

10000

29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97Year

Billions

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Why does consumption fall by 20% between 1929 and 1933?Why does consumption fall by 20% between 1929 and 1933? income has fallen and a large fraction of people income has fallen and a large fraction of people

are unemployedare unemployed times are bad, sentiment and expectations are times are bad, sentiment and expectations are

low, and people save for a rainy day if they canlow, and people save for a rainy day if they can wealth has decreasedwealth has decreased

for example, the stock market crash of 1929 for example, the stock market crash of 1929 decreased the wealth of investors in stocks, and decreased the wealth of investors in stocks, and decreased consumption out of wealthdecreased consumption out of wealth

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Gross Private Domestic Investment, Millions 92 $ .

1933 trough

1982 trough

1991 trough

0

200

400

600

800

1000

1200

1400

29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97Year

Millions

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Why does investment fall from $92.4 B in’29 to $9.9 B in ‘32? 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 Not only are many people idle, so is much of plant and

equipmentequipment with existing capital redundant, there is less urgency to invest with existing capital redundant, there is less urgency to invest

in new equipmentin new equipment times are bad, consumers are not buying, and businesses times are bad, consumers are not buying, and businesses

are failing, so business sentiment and expectations are loware failing, so business sentiment and expectations are low if there is any cash flow, businesses may decide to keep it if there is any cash flow, businesses may decide to keep it

as cash reserve against the unexpected event rather than as cash reserve against the unexpected event rather than invest it invest it

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Gross Domestic Product Components in 1929 . .

investment16%

net exports0% government

9%

consumption75%

federal government was 1.6%, whilestate & local government was 7.3%

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What were the policy options in 1933?What were the policy options in 1933?

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Were consumers & firms afraid to spend?Were consumers & firms afraid to spend?

Fear

Consumers

Firms

? $

? $

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Impact of the Great Depression on Economic ThoughtImpact of the Great Depression on Economic Thought The conventional wisdom at that time was to wait, The conventional wisdom at that time was to wait,

and the economy would recoverand the economy would recover The Englishman John Maynard Keynes was not The Englishman John Maynard Keynes was not

only a great economist but was aware of the only a great economist but was aware of the political danger the depression posed to capitalismpolitical danger the depression posed to capitalism he realized that it would be difficult to convince he realized that it would be difficult to convince

consumers and businesses to spend more in the consumers and businesses to spend more in the depths of a recessiondepths of a recession

he emphasized the importance of uncertainty he emphasized the importance of uncertainty and expectations on behaviorand expectations on behavior

he stressed an aggregate expenditures he stressed an aggregate expenditures perspective and a role for government spendingperspective and a role for government spending

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A simple Keynesian modelA simple Keynesian model The aggregate demand emphasisThe aggregate demand emphasis

for simplicity, ignore net exports and government for simplicity, ignore net exports and government expenditure, small in ‘29expenditure, small in ‘29

Aggregate expenditures, GDP, equals consumption, Aggregate expenditures, GDP, equals consumption, C, plus investment, IC, plus investment, I GDP = C + IGDP = C + I

National Income, Y, equals consumption, C, plus National Income, Y, equals consumption, C, plus savings, S savings, S

In Equilibrium, Aggregate Expenditures, GDP In Equilibrium, Aggregate Expenditures, GDP equals National Income, Y equals National Income, Y GDP = Y GDP = Y so C + I = C + Sso C + I = C + S and, in equilibrium, savings equals and, in equilibrium, savings equals investmentinvestment

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A simple Keynesian ModelA simple Keynesian Model The Consumption FunctionThe Consumption Function

consumption expenditures has two componentsconsumption expenditures has two components autonomous consumption,Cautonomous consumption,C0 0 ,that does not vary with ,that does not vary with

income, for example, even if income was zero, there income, for example, even if income was zero, there would be some spending out of wealth; shifts with would be some spending out of wealth; shifts with fearfear

a component that increases with income but not $ a component that increases with income but not $ for $, allowing for some savingsfor $, allowing for some savings

InvestmentInvestment assume investment, I, is autonomous, i.e. does assume investment, I, is autonomous, i.e. does

not vary with income, Y; shifts with fearnot vary with income, Y; shifts with fear

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consumption, C

Income, Y

autonomousconsumption, C0

The Consumption Function

C = C0 + mpc* Y

the slope of the consumption function,the marginal compensity to consume,mpc, is the increase in consumptionper $ increase in income

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Autonomous Investment

Investment, I

Income, Y

I

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Consumption, CInvestment, IGDP

Income, Y


Gross Domestic Product Equals Consumption Plus Investment

C = C0 + mpc* Y

I

GDP = C + I

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Squares with Equal Sides and 45 degree Lines

Income, Y

Income, Y

Y1

Y1

450

Y = Y

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Income


Equilibrium Level of Gross Domestic Product GDP=Y

C = C0 + mpc* Y

I

GDP = C + I

GDP=Y

GDP=Y

450

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Income


Equilibrium Level of Gross Domestic Product GDP=Y

GDP = C + I

GDP=Y

GDP=Y

450

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Income, Y

Less than Full Employment Equilibrium

C = C0 + mpc* Y

I

GDP = C + I

450

GDP = Y YFE

Full Employment Income

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Income, Y

Less than Full Employment Equilibrium

GDP = C + I

450

GDP = Y YFE

Full Employment Income

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Policy OptionPolicy Option

“The only thing we have to fear is fear itself”

Franklin Delano Roosevelt

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Policy OptionPolicy OptionGovernment As a Fraction of GDP .

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97Year

Fraction

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Summary-Vocabulary-ConceptsSummary-Vocabulary-Concepts national incomenational income circular flow economycircular flow economy value addedvalue added gross domestic productgross domestic product consumptionconsumption gross private domestic gross private domestic

investmentinvestment government government

expendituresexpenditures net exportsnet exports aggregate production aggregate production

functionfunction

nominal GDPnominal GDP closed economyclosed economy John Maynard KeynesJohn Maynard Keynes aggregate expendituresaggregate expenditures uncertaintyuncertainty expectationsexpectations consumption functionconsumption function autonomous consumptionautonomous consumption marginal propensity to consumemarginal propensity to consume equilibrium GDPequilibrium GDP full employment GDPfull employment GDP

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Quiz Results

Total # 138Late 1Absent 5

Score Grade Number39-40 A+ 737-38 A 1735-36 A- 1933-34 B+ 2631-32 B 2529-30 B- 1127-28 C+ 1525-26 C 623-24 C- 421-22 D+ 119-20 D 417-18 D- 2 -16 F 1

Llad Phillips1 Introduction to Economics Macroeconomics The US Economy.

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Transcript of Llad Phillips1 Introduction to Economics Macroeconomics The US Economy.