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Introduction to Economics Macroeconomics The US Economy Llad Phillips 1 Outline: Lexture Six News: Fed Cuts Interest Rates; Dow up 330 National Income Accounting The Great Depression Llad Phillips 2 News Why did the Fed cut interest rates? Why did the Dow go up 330? What effect will lower interest rates have on consumers? Is a recession coming? How Llad Phillips could you figure that out? 3 Review Part II: Chapter Three Conceptual Framework: Circular Flow Firms Income Firms Labor Supply Goods Demand Goods Households Households Income Perspective Expenditure Perspective Llad Phillips 4 Expenditure Perspective Firms Supply Goods Demand For Goods Consumption Households Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Llad Phillips 5 Expenditure Perspective: Closed Firms Supply Goods Demand Goods Households Government Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Government: Expenditures on Goods and Services Llad Phillips 6 Expenditure Perspective: Open Firms Exports (Sales) Supply Goods Demand Goods Imports (puchases) Households Government Households: Consumption of Goods and Services Firms: Investment in Plant and Equipment Government: Purchase of Goods and Services All Three: Exports - Imports = Net Exports Llad Phillips 7 What has been happening to expenditure in the last year? Sources of information US Department of Commerce: Survey of Current Business The Conference Board: Business Cycle Indicators Llad Phillips 8 Lab Three: National Income and Product Accounts (NIPA)-Ch. 20 Billions of 1992 $ 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 GDP is Gross Domestic Product Llad Phillips 9 Federal Reserve Bank: Philadelphia http://www.phil.frb.org/ Economics/Survey of Professional Forecasters August 21, 1988 98 III 98 IV 99 I 99 II 99 III GDP 7530.0 7587.0 7629.9 7668.8 7716.3 B 92$ 2.5 2.1 2.3 3.1 GDP% 2.1 Increase -271.8 -280.0 -287.6 -289.7 -287.3 Net Exports B$ Llad Phillips 10 Dr. Ed Yardeni, Deutsch Bank Securities http://www.yardeni.com September 24, 1998 98 98 98 98 99 99 99 I II III IV I II III 99 IV Real 5.5 1.8 3.0 2.5 2.2 1.5 0.0 -1.0 GDP % Increase Consum 6.1 6.1 3.4 2.7 1.9 1.5 0.9 0.0 -ption % Increase Llad Phillips 11 Index of Consumer Confidence Lab One:http://www.mlinet.com/mle/econdata.htm Last Recession ‘91 ‘70-’95 Llad Phillips 12 Llad Phillips Date 13 98.09 98.07 98.05 98.03 98.01 97.11 9.09 97.07 97.05 97.03 97.01 96.11 96.09 96.07 96.05 96.03 96.01 Index Monthly Index of Consumer Confidence, 1985=100 . 140 120 100 80 60 40 20 0 How Bad Could It Get? Great Depression Llad Phillips 14 The Great Depression Impact on the US Economy Impact on Economic Thinking as a Consequence Llad Phillips 15 Unemployed Persons, Millions, 1929-1997 . 14 1933 trough 1982 trough 12 1938 trough 1991 trough 8 6 4 2 1945 trough Year Llad Phillips 16 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 0 29 Millions 10 Unemployment the number of unemployed persons increased from 1,550,000 in 1929 to 12,830,000 in 1933 in 1933, 25% of those who wanted work, and were willing to look for work, could not find a job the depression of the thirties was nearly an order of magnitude worse than subsequent recessions unemployment is cyclical, rising in bad times and falling in good times Llad Phillips 17 What happened in the early 30’s? An aggregate expenditures perspective gross domestic product: its components personal consumption expenditures gross private domestic investment exports minus imports = net exports government expenditures Llad Phillips 18 Personal Consumption Expenditures, Billions of '92 $ . 5000 1997 4500 4000 3000 2500 2000 1500 1929 1000 500 Year Llad Phillips 19 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 0 29 Billions 3500 Personal Consumption Expenditures, Billions of '92 $ . 10000 1000 1929 Year Llad Phillips 20 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 100 29 Billions 1997 Why does consumption fall by 20% between 1929 and 1933? 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 wealth has decreased for example, the stock market crash of 1929 decreased the wealth of investors in stocks, and decreased consumption out of wealth Llad Phillips 21 Gross Private Domestic Investment, Millions 92 $ . 1400 1200 800 1991 trough 600 1982 trough 400 1933 trough 200 Year Llad Phillips 22 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 0 29 Millions 1000 Why does investment fall from $92.4 B in’29 to $9.9 B in ‘32? Not only are many people idle, so is much of plant and equipment with existing capital redundant, there is less urgency to invest in new equipment times are bad, consumers are not buying, and businesses are failing, so business sentiment and expectations are low if there is any cash flow, businesses may decide to keep it as cash reserve against the unexpected event rather than invest it Llad Phillips 23 Gross Domestic Product Components in 1929 . . net exports 0% investment 16% government 9% federal government was 1.6%, while state & local government was 7.3% consumption 75% Llad Phillips 24 What were the policy options in 1933? Llad Phillips 25 Were consumers & firms afraid to spend? Consumers ?$ Fear Firms Llad Phillips ?$ 26 Impact of the Great Depression on Economic Thought 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 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 Llad Phillips 27 perspective and a role for government spending A simple Keynesian model The aggregate demand emphasis for simplicity, ignore net exports and government expenditure, small in ‘29 Aggregate expenditures, GDP, equals consumption, C, plus investment, I GDP = C+I National Income, Y, equals consumption, C, plus savings, S In Equilibrium, Aggregate Expenditures, GDP equals National Income, Y GDP = Y so C+I=C+S and, Llad Phillips in equilibrium, savings equals investment 28 A simple Keynesian Model The Consumption Function consumption expenditures has two components autonomous consumption,C0 ,that does not vary with income, for example, even if income was zero, there would be some spending out of wealth; shifts with fear a component that increases with income but not $ for $, allowing for some savings Investment assume investment, I, is autonomous, i.e. does not vary with income, Y; shifts with fear Llad Phillips 29 The Consumption Function consumption, C autonomous consumption, C0 C = C0 + mpc* Y the slope of the consumption function, the marginal compensity to consume, mpc, is the increase in consumption per $ increase in income Income, Y Llad Phillips 30 Autonomous Investment Investment, I I Income, Y Llad Phillips 31 Gross Domestic Product Equals Consumption Plus Investment Consumption, C Investment, I GDP autonomous consumption, C0 GDP = C + I C = C0 + mpc* Y I Income, Y Llad Phillips 32 Squares with Equal Sides and 45 degree Lines Y=Y Income, Y Y1 450 Y1 Llad Phillips Income, Y 33 Equilibrium Level of Gross Domestic Product GDP=Y GDP=Y Consumption, C Investment, I GDP GDP = C + I C = C0 + mpc* Y autonomous consumption, C0 I 450 GDP=Y Llad Phillips Income 34 Equilibrium Level of Gross Domestic Product GDP=Y GDP=Y Consumption, C Investment, I GDP GDP = C + I autonomous consumption, C0 450 GDP=Y Llad Phillips Income 35 Less than Full Employment Equilibrium Consumption, C GDP = C + I Investment, I GDP C = C0 + mpc* Y I 450 GDP = Y Llad Phillips Full Employment Income YFE Income, Y 36 Less than Full Employment Equilibrium Consumption, C GDP = C + I Investment, I GDP 450 GDP = Y Llad Phillips Full Employment Income YFE Income, Y 37 Policy Option “The only thing we have to fear is fear itself” Franklin Delano Roosevelt Llad Phillips 38 Policy Option Government As a Fraction of GDP . 0.5 0.45 0.4 0.3 0.25 0.2 0.15 0.1 0.05 Year Llad Phillips 39 97 93 89 85 81 77 73 69 65 61 57 53 49 45 41 37 33 0 29 Fraction 0.35 Summary-Vocabulary-Concepts national income circular flow economy value added gross domestic product consumption gross private domestic investment government expenditures net exports aggregate production function Llad Phillips nominal GDP closed economy John Maynard Keynes aggregate expenditures uncertainty expectations consumption function autonomous consumption marginal propensity to consume equilibrium GDP 40 Score 39-40 37-38 35-36 33-34 31-32 29-30 27-28 25-26 23-24 21-22 19-20 17-18 -16 Llad Phillips Grade A+ A AB+ B BC+ C CD+ D DF Number 7 17 19 26 25 11 15 6 4 1 4 2 1 Quiz Results Total # 138 Late 1 Absent 5 41