Transcript Economics, by R. Glenn Hubbard and Anthony Patrick O`Brien

Retail Sales
(Measures changes in Consumer Spending Patterns)
Web: www.census.gov/svsd/www/advtable.html
Economic
Indicator 3
Large revisions with annual changes in March
Retail sales represents 1/3 of consumer spending, PCE, which makes up 70% of the economy
Census bureau surveys 5000 retailers 3 days after month end for their latest sales numbers.
Retail sales represent spending on goods only, not services – air travel, medical care, dental care, haircuts, insurance, movies, etc. – which represent 2/3 of personal
expenditures.
Measured in nominal/current dollars PtYt (not inflation adjusted) so don’t know if change is due to change in prices, change in volume or both. But economic
performance is based on real growth rates (volume effect). So subtract percentage change in consumer price index to get good approximation of real
percentage change in sales.
Retail sales = Total sales receipts – returned merchandise – rebates – sales tax – excise tax – finance charges.
Adjusted for seasonal variations (holidays, winter, etc.)
Use a 3-month moving average to get more accurate sense of underlying trend.
Strong correlation between change real retail sales and real GDP
(DGDP/GDP)Et+1 = F [PCE = f (retail sales)]
Subtract out the large (25%) but volatile motor vehicle category to better track underlying consumer spending trend.
Watch for changes in gas prices which can change retail sales.  PGas =>  retail sales but  non-gas retail sales
D(PY) = DPY1 + DYP1 + DPDY
D(PY) = DPY1 + DYP1 + DPDY
P1Y1 P1Y1
P1Y1 P1Y1
D(PY) = DP + DY + 0
P1Y1 P1
Y1
if DP and DY are small
DY = D(PY) – DP
Y1
P1Y1 P1
-------------------------------------------------------------------------------------------------------------------------Market Analysis
Bonds:  retail sales =>  DY/Y =>  DP/P =>  DBonds =>  iBonds
Stocks:  retail sales =>  revenues =>  profits =>  PStocks
Many goods are imported =>  demand for euros/supply of dollars =>  P$
Dollar:  income =>  imports =>  retail sales and trade deficit
Retail Sales (excluding autos)
(year over year % change)
12
11
10
9
8
7
6
5
4
3
2
1
0
-1 96
-2
-3
-4
-5
-6
-7
-8
-9
-10
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
12
11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
-10
The Essence of Economics
Limited Resources => Limited Goods/Services < Unlimited Desires
Scarcity/Constraints
Outputs
Decreasing Marginal Product => Increasing Marginal Cost => Upward Sloping Supply Curve
Y
Production Function,… y = f (x),….technology
X
Inputs / Resources / Factors of Production
Scarcity The situation in which unlimited wants exceed the limited resources available to fulfill those wants.
Trade-off The idea that because of scarcity, producing more of one good or service means producing less
of another good or service.
Scarcity => Tradeoffs => Choice
Economics The study of the choices people make to attain
their goals, given their scarce resources.
Scarcity
Limited Resources => Limited Goods/Services < Wants
Poverty
Limited Resources => Limited Goods/Services < Needs
U.S Poverty Rate
% Below Poverty Level
(46.2 million in poverty)
16
15.1
15.1 15.0
14.8
15
14.5
14.3
14.2
14
13.8 13.7
13.5
13.4
13.0
13
13.3
12.8
13.2
12.7
12.7 12.6
12.5
12.1
11.9
12
12.3
12.5
11.7
11.3
11
10
9
8
87
88
89
90
91
Source: U.S Censu Bureau
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
Production Function
4
Output, Y
3
2
1
0
0
1
2
3
4
5
Input, X
6
7
8
9
Production Function
4
Output, Y
3
2
1
0
0
1
2
3
4
5
Input, X
6
7
8
9
16 Economic Principles
#1 Choices are necessary because resources are scarce
A resource is anything that can be used to produce something else: land labor, capital, and human
capital. Resources are scarce – the quantity available is not large enough to satisfy all
productive uses.
#2 The true cost of something is its opportunity cost
The real cost of an item is its opportunity cost: what you must give up in order to get it. Opportunity
cost is not only monetary cost.
16 Economic Principles
#3 “How much” is a decision at the margin
Most decisions of interest to economists involve decisions at the margin. You make a tradeoff
when you compare the costs with the benefits of doing something. Decisions about whether to
do a bit more or a bit less of an activity are marginal decisions. The study of such decisions is
known as marginal analysis.
Marginal Analysis: Compare marginal costs to marginal benefits
Optimal decisions are made on the margin,…spend a little more, save a little less vs. all or
nothing. An activity should be continued to the point where the marginal benefit is equal to the
marginal cost.
#4 People usually respond to incentives, exploiting opportunities to
make themselves better off
1.
People will exploit opportunities until the opportunities are fully exhausted. People respond to
incentives. An incentive is anything that offers a reward to people who change their behavior.
Incentives Matter
•
Q. D. = F( P; Income, tastes, expectations,…..)
•
Q. S. = F( P; technology,……)
16 Economic Principles
#5 There are gains from trade
In a market economy individuals engage in trade – they provide goods and services to others and
receive goods and services in return. There are gains from trade – people can get more of what
they want through trade than they could if they tried to be self-sufficient. This increase in
output is due to specialization – each person specializes in the task that he or she is good at
performing.
#6 Markets move towards equilibrium
An economic situation is in equilibrium when no individual would be better off taking a different
action.
16 Economic Principles
#7 Resources should be used efficiently to achieve society’s goals
An economy is efficient if it takes all opportunities to make some people better off without making
others worse off. When an economy is efficient, it is producing the maximum gains from trade
possible, given the resources available. There are tradeoffs between using resources efficiently
and attaining equity in the distribution of goods
#8 Markets usually lead to efficiency
The incentives built into a market economy ensure that resources are usually put to good use, that all
opportunities to make everyone better off have been exploited. The economy as a whole
benefits if each individual specializes in a task and trades with others.
16 Economic Principles
#9 When markets don’t achieve efficiency, government
intervention can improve society’s welfare
Markets fail to achieve for three principal reasons
1.
Externalities - Individual actions have side effects that are not properly taken into account.
2.
Competition - Some markets are not competitive so one party attempts to capture a greater
share of resources for itself.
3.
Public goods – some goods by their very nature are unsuited for efficient management by
markets.
4.
Asymmetric information – not all market participants have full information when making
decisions
#10 One person’s spending is another person’s income
16 Economic Principles
#11 Overall spending sometimes gets out of line with the
economy’s productive capacity
#12 Government policies can affect the macroeconomy
1.
2.
3.
Government can change its own spending
Government can vary how much it collects from the public in taxes
Government can control the quantity of money in circulation
16 Economic Principles
#13 Information is scarce => uncertainty is fact of life
#14 Economic events => primary and secondary effects
•
•
Law of unintended consequences
Effective policy evaluation looks for indirect effects
16 Economic Principles
#15 Value of goods/services are subjective
#16 The test of an economic theory is its ability to predict and
explain events in the real world
•
•
Positive analysis: Analysis concerned with what is.
Normative analysis: Analysis concerned with what ought to be.
–
–
Equity: The fair distribution of economic benefits.
Equity Tradeoff: Increase equity => decrease efficiency
4 Pitfalls to avoid in Economic Thinking
1. Violation of Ceteris Paribus.
•
2.
Hold “other things equal”
Good intentions do not guarantee desirable outcomes
•
•
Unsound proposal => undesirable outcomes
Political games
3. Fallacy of Composition
•
•
Erroneous view that what is true for the individual is also true for
the whole
Micro vs Macro Economics
4. Association is not Causation
•
Logical fallacy: Post Hoc Ergo Propter Hoc
The Scientific Method Applied to Social Sciences
Economic Model – simplified version of reality.
Economic models/theories make behavioral assumptions about economic agent
motives.
5 Steps to Develop and Test an Economic Model
1.
2.
3.
4.
5.
Decide on the assumptions to be used in developing the model.
Formulate a testable hypothesis - is a statement that may be either correct or
incorrect about an economic variable. Economic hypothesis are usually
about a causal relationship; X => Y
Use economic data to test hypothesis – analyze statistics on relevant
economic variables to access the question, did X cause Y?
Revise the model if it fails to explain well the economic data.
Retain the revised model to help answer similar economic questions in the
future.
Interest Rates and Recessions
1988-2011
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3
2
2
1
1
0
0
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Recession
Baa
Fed Funds
10-yr Treas
Real Fed Funds
(fed funds - core CPI)
12
10
4% = Recession causing
level
8
6
4
2
0
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
-2
-4
0.10% - 2.0% = -1.9%
-6
-8
8
10
12
Eight Problems when Determining Cause and Effect Relationships
(causal inference)
1.
2.
3.
4.
5.
6.
7.
8.
Has correlation (happening at the same time) been confused with causation.
Common cause;. X and Y are effects of a common cause Z.
DZ ==> DX
DZ ======> DY
Has temporality (chronological sequence) been confused with causality. This is the
“post hoc fallacy”. Just because X preceded Y, doesn’t mean X caused Y.
Are there significant multiple causes and effects. An effect might have multiple
causes, so treating only one of them might not alter the presence of the effect.
Have cause and effect been reversed; DX => DY,….or maybe DY => DX.
Which way is the causal inference?
The economy is always changing (hard to assume ceterus paribus) and it is virtually
impossible to conduct controlled economic experiments.
Third variable. There may be an omitted variable/factor causing the relationship.
Are there intervening or counteracting causes. Both will reduce causal force brought
to bear on the alleged effect.
If statistical analysis confirms hypothesis, then accept economic model/theory.
Rather than being “accepted”, hypothesis are considered “not rejected” .
The Market A group of buyers and sellers of a good or service and the
institution or arrangement by which they come together to trade.
Price
Determined by Utility Maximization
Marginal Benefit per unit
Maximum willingness to pay
S
Determined by Profit Maximization
Marginal Cost per unit
Minimum willing to receive
P*
D
Voluntary exchange The situation that occurs in markets
when both the buyer and seller of a product
are made better off by the transaction.
Q*
Quantity Demanded/Supplied
Price
The Market Economy & Resource Allocation
S
Determined by profit Maximization
P*
Determined by Utility Maximization
D
Q*
Quantity Demanded/Supplied
Market economy An economy in which the
decisions of households and firms interacting in
markets allocate economic resources.
X
Production Function
Inputs
Y
Centrally planned economy An economy in which
the government decides how economic resources
will be allocated.
Market
Price
S
Productive efficiency
The situation in which a good or service
is produced at the lowest possible cost.
P*
D
Q*
Y
Quantity Demanded/Supplied
Allocative efficiency A state of the economy in which production
reflects consumer preferences; in particular, every good or service is produced
up to the point where the last unit provides a marginal benefit to consumers
equal to the marginal cost of producing it.
1st Theorem of Welfare Economics
Markets => firm competition & voluntary exchange => Efficient Outcome
Valve = Price
# of threads = elasticity
Quantity Supplied per year
Inflow/Production
Adam Smith’s
Invisible Hand
Water/Inventory/Stock
Equilibrium Condition
Inflow = Outflow
QS = QD
Determines Price/Valve turns
Quantity demanded
per year
Outflow/Sales
Personal Income, Spending & Savings
Economic
Indicator 4
(Gauge of Economic Activity)
Web: www.bea.doc.gov/bea/newsreleases/rels.htm
Revisions for several months after initial release. Annual revisions done every summer. Benchmarked every 5 years.
Income + DDebt = Taxes
+
Debt Interest
Wages & salaries 51%
Proprietors income 8%
Rental income 3%
Dividend income 5%
Interest income 8%
Transfer payments 17%
Other labor income 8%
+
Spending
+
Savings
Durable goods
10% - 15%
Nondurable goods 20% - 25%
Services
60% - 70%
D Debt = borrowing future income for current consumption
Debt Interest = interest payments on consumer loans to creditors (consumption expense). If Interest payments-to-DPI > 2.5%, then households may be experiencing financial stress
and future spending may suffer.
Spending = Personal Consumption Expenditures, PCE, make up over 70% of total GDP
Savings = residual = Y – T – C – I = S – DD. Does not include capital gains on stocks, bonds, real estate.
Spending is a function of income, DWealth and DP/P.
 Incomet =>  C t+1
If  PStock = $1, then  C = 3-6 cents
If  PHouse = $1, then  C = 2-4 cents
Real disposable personal income is a better portent of future consumer demand. Best measure of true consumer purchasing power. Dreal DPI foreshadows D spending
Watch for precipitous changes in savings rates. Indicator of households’ concerns of financial future
 income/job security =>  savings rate =>  C
 optimism =>  savings rate =>  interest rates =>  investment
Durable goods are expensive, often involve financing, and are sensitive to swings in the economy
 income/job stability =>  durable goods orders =>  production
Excellent predictor of economic turning points
 durable good orders =>(6-12 months) recession onset
 durable good orders =>(1-2 months) recession ends/recovery begins
The latest 3-month change in real PCE is a good indicator of quarterly GDP
PCE Price index – Best measure of consumer inflation. Federal Reserve uses when setting interest rate policy. Typically 0.3 percentage points lower than CPI because it takes
account of changing buying habits as relative prices change (substitution effect). Fed targets the PCE Price Index in the 1.75%-2.0% range.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Market Analysis
Bonds: Strong income/spending numbers =>  DY/Y =>  DP/P =>  Federal Reserve rates =>  DBonds=>  iBonds
Stocks: Strong income/spending numbers =>  DY/Y =>  profits =>  PStocks
Dollar: Strong income/spending numbers =>  DY/Y =>  iBonds =>  DDollar =>  PDollar
Personal Income & Consumption Expenditures
[Year Over Year % Change]
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88 89
90 91
92 93 94
95 96
97 98 99
00 01
02 03
04 05 06
07 08
09 10 11
12 13
-1
-2
-3
-4
Recession
Consumption
Income
-5
-6