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Introduction to Economics

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Advertised 2-Year Lease Deal for a 1996 Taurus ... Buying a New 96 Taurus. Knowns. advertised price tax documents: ... Cost of Using a 96 Taurus for 2 Yrs. ... – PowerPoint PPT presentation

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Title: Introduction to Economics


1
Introduction to Economics
  • Elements of Personal Finance

2
Econ 109 Class Page
  • Econ Home Page http//www.econ.ucsb.edu

3
Economics 109 Llad Phillips Fall
2002 Introduction to Economics Hour, Location
200-315, Engineering 1104 Instructor Llad
Phillips, Llad_at_econ.ucsb.edu Office Hours NH
3032, 930-1015 TuTh and 1030-1115 W, and by
appointment Arthur OSullivan and Steven
Sheffrin, Economics, Principles and Tools,
Third Edition(2003,2001)
4
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5
Concepts in Economics
  • This Time How to think like an economist, the
    economic paradigm
  • This Time You pay for the service of the car
    one year, two years, three years
  • Last Time scarcity
  • Last Time opportunity cost

6
Personal Finance Examples
  • Buying a Car
  • The most important thing about the example is
    process

7
Economists have a name for this process The
Economic Paradigm
  • Step One List your options for choice
  • for example pay cash or keep the cash

8
Economists have a name for this process The
Economic Paradigm
  • Step One
  • Step Three pick the best option for you
  • for example keep the cash

9
What Happened to Step Two?
  • Step Two value the options

10
Economics Two Types of Issues
  • Efficiency
  • step 3 of the paradigm pick the best option
  • optimize
  • Equity

11
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12
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13
What is the next most important thing to remember
from the car example?
  • Two Main Costs
  • depreciation
  • foregone interest

14
Depreciation Taurus, GL Sedan
15
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16
Walnut Creek Ford Dealer
  • 1996 Taurus
  • Advertised Price 16,488

17
Choice cash
  • purchase price 16,488
  • tax at 7.5 1,237
  • documents 35
  • total 17,760

18
This Year
???Next Year
Year After
Keep Your Money
17,760
17,760
17,760
1,225
1,225
1,225
17,760
18,985
20,210
_at_ 6.9 interest
Buy The Car, Cash
Cars Services For 1 Yr.
Cars Services For 2 Yrs.
Resale value
14,947
13,538
MSRP - Depreciation MSRP - MSRP 0.194
18,545 0.806
MSRP - Depreciation MSRP - MSRP 0.27
18,545 0.73
Cost of Cars Services 4,038(1 Yr.) 6,672(2
Yrs.)
19
Another Decision How to Pay?
20
Choice of Payment Method
  • cash
  • lease
  • loan

21
http//www.fordcredit.com/
22
Advertised 2-Year Lease Deal for a 1996 Taurus
  • drive-off costs(payments due at lease signing)
    2,136.77
  • monthly Payment 249 tax
  • remember tax documents 1237 35 1272,
    spread over 24 months, or 53 per month
  • total monthly payment 249 53 302
  • total payments 243027248
  • drive-off payments 9384.77

23
Walnut Creek Dealer 1996, Ford Taurus, 16,488
Example
?????????
5,976 tax
249 tax
????????
24
Example
249 tax
24 months
5,976 tax
25
Buy The Car, Cash
This Year
???Next Year
Year After
2,450
1,225
foregone interest on 17,760
4,222
depreciation
2,813
_at_ 6.9 interest
6,672
4,038
pricetax-blue book 17,760 - 0.80618,545
Lease, 24 months
total drive-off
2,137
2,137
total monthly payments _at_302/m.
3,624
7,248
147
294
foregone interest on 2,137
5908
9679
Assumes no opportunity cost of monthly payments
26
What is the advantage of leasing?
  • Low drive-off compared to paying 17,760 cash

27
http//www.fordcredit.com/calculator/calcbuffer.ht
ml
28
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29
Cost of Using a 96 Taurus for 2 Yrs.
foregone interest on the drive-off of 2,137
30
Elements of Personal Finance
  • Economics in every day life
  • loans
  • car loans

31
Example Buying a New 96 Taurus
  • Knowns
  • advertised price tax documents 17,760
  • down payment 2,137
  • loan amount 15,623
  • loan amount 17,760 - 2,137
  • annual interest rate 6.9
  • loan term in months 24 months
  • Unknowns
  • monthly payment

32
Monthly Payment?
  • Could use Ford calculator, but that was for a 48
    month loan
  • could use the program Excel

33
Using Excel 5.0 for a Solution
Monthly Payment?
34
Cost of Using a 96 Taurus for 2 Yrs.
residual value 11,480 vs. Kelly Blue Book
resale value of 13,538
blue book 13,538
35
Catch 22
  • The 2-year loan looks best
  • But, . Ford was not offering a 2-year loan, but
    a 4-year loan

36
Some General Facts About Loans
  • From our car loan example

37
Using Excel 5.0 for a Solution
38
Increasing the Length of the LoanTradeoffs
  • monthly payment amount decreases
  • amount of total payments increases
  • amount of total interest payments increases
  • total interest as of total payments increases

39
Using Excel 5.0 for a Solution
40
Interest as a Fraction of Cost
41
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42
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43
Summary Loans
  • interest is front-loaded in payment plan
  • interest cost increases with the loan term
  • total cost increases with the loan term
  • equity is low at the beginning of the loan

44
Personal Financial Planning
  • Financing Life Events

45
Life Event Approach
  • Marriage/commitment to significant other
  • children
  • financial security insurance
  • housing
  • education
  • retirement
  • long term care
  • estate

reference Ernst Youngs Personal Financial
Planning Guide, 2nd Ed. John Wiley
46
Life Cycle Approach Learning Earning
Activity/Phase
High School Education
Nurturing
College
Retirement
Work
Age
Infancy
Adolescence
Young Adult
Adult
Senescence
47
Life Cycle Approach The Planners
100
You
50
Parents
0
Age
Infancy
Adolescence
Young Adult
Adult
Senescence
48
Life Cycle Approach Planning
Education Investment in Human Capital or
Earning Power
Accumulating Assets cars appliances
furnishings --------------------- house
financial assets
Spending
Age
Nurturing
High School Education
College
Work
Retirement
49
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50
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51
Planning Tools
  • Assets-Liabilities Statement
  • Assets Minus Liabilities Net Worth
  • measure of wealth
  • Income-Expenditure Statement
  • Income Minus Expenditures Saving
  • measure of change in wealth

52
http//www.fordcredi.com/fplanner.cgi
53
Income-Expense Statement
54
Income-Expense Statement US Population 1988
other health, 5 pensions Soc. Sec., 7
other, 15 Source Guide to Understanding
Personal Finance, p. 87
55
Assets-Liabilities Statement
56
Strategies for Meeting Future Expenses
  • Buy a House
  • Tax-Sheltered Savings Plans
  • Stocks and Bonds

57
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58
Buying a House
  • Negatives?
  • down payment requires saving for this goal
  • interest payments are front-loaded, equity growth
    delayed
  • opportunity cost of not investing in stocks
  • Positives
  • provides space
  • builds equity
  • interest is deductible

59
Summary - Vocabulary - Concepts
  • economic paradigm
  • down payment
  • loan term
  • monthly payment
  • annual percentage rate or APR
  • equity
  • personal financial planning
  • life event ananysis
  • human capital
  • assets
  • liabilities
  • net worth, wealth
  • income
  • expenditures
  • savings

60
Excel select cell for monthly payment, click on
Function Wizard
select Financial and PMT
61
Excel click on the help button in the previous
window for examples
62
The Economic Approach to Problem Solving
  • The Economic Paradigm

63
The Economic Paradigm
  • describing the alternatives to choose among
  • pricing the alternatives
  • choosing the best alternative

64
The Economic Paradigm example buying a car
  • describing the alternatives to choose among
  • cash the opportunity cost of losing interest
  • lease depreciation included in payments
  • loan sell the car to account for depreciation
  • pricing the alternatives valuation
  • Oscar Wilde- economists know the price of
    everything and the value of nothing
  • choosing the best alternative
  • best lowest cost
  • possibly subject to a constraint having the

65
The Principle of Opportunity Cost
  • No matter what we do, there are always tradeoffs.
  • Scarcity -- limited resources -- is the reason.
  • The opportunity cost of something is what you
    sacrifice to get it.

66
Opportunity Costs and Production Possibilities
  • The production possibility curve illustrates the
    principle of opportunity cost for an entire
    economy.
  • -- shows all possible combinations of goods
    and services available to entire economy.
  • --- principle of opportunity cost explains
    why production possibility curve is negatively
    sloped.

67
THE MARGINAL PRINCIPLE
  • Marginal Benefit
  • The extra benefit resulting from a small
    increase in the activity.
  • Marginal Cost
  • The additional cost resulting from a small
    increase in the activity.
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