ECONOMIC ISSUES AND SOME SIMPLE ECONOMIC MODELS

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ECONOMIC ISSUES AND SOME SIMPLE ECONOMIC MODELS

• BA 780
• Second Lecture, September 3, 2009
• William R. Eadington
• eadington_at_prodigy.net

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THOUGHTS AND QUESTIONS FROM NAKED ECONOMICS

• Why did the Soviet Union collapse?
• Ross Perot The Great Sucking Sound
• French 35 hour work week
• Why do Americans drive big cars? Are they too
  big?
• What caused the Savings and Loan crisis in the
  1980s?
• Who feeds Paris (or New York)?
• Self-interest Utility and Profits the role of
  incentives
• Heroin production in Afghanistan
• Fee for service Doctors in America

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NAKED ECONOMICS More Questions

• Why are Brazilians cutting down the rain forests?
  What does this say about their views toward the
  environment?
• If a female neurologist quits her job to raise
  her new baby, what is the cost?
• Why doesnt Tom Cruise sell automobile insurance?
• What is the logic behind airlines selling tickets
  to the same place at different prices?
• Are Asian sweatshops something we should protest
  about (if we are concerned about the poor
  children of Indonesia?)
• Why is the Black Rhino in danger, and what should
  be done about it?
• In 1989, East German car factories were
  destroying value. Explain.
• Is it a good idea to require child restraint
  seats in commercial airlines? Why or why not?
• Why is your meal free at Burger King if you do
  not get a receipt?
• Why should you be wary of your real estate agent?

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BASIC MACRO-ECONOMIC OBJECTIVES

• Maximize economic well-being, over time
• Real per capita income
• Reasonable distribution of income
• Price stability
• Full employment
• Economic growth
• Efficient utilization of resources

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WHERE DOES ECONOMIC ACTIVITY TAKE PLACE? HOW CAN
WE MEASURE IT?

• FACTS, CONCEPTS AND MODELS
• Identifying objectives and variables whose
  performance can fulfill those objectives
• Models are simplifications of interactions among
  key variables
• KEY MEASURES LINKING CONCEPTS TO VARIABLES TO
  ESTIMATE
• National economic well-being
• Income per capita
• GDP
• Real GDP
• Rate of Growth
• Employment levels, resource utilization
• Inflation rates, extent of debt burden

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DYNAMICS OF GROWTH

• How can we bring about more rapid economic
  growth? Should we?
• How will the American economy fare over the next
  30 years? Will the 21st century belong to
  another country?
• How does the economy grow over time?
• What is the role of Aggregate Demand? How
  important is it compared to Supply?
• Short term strategies Avoiding recession and
  inflation encouraging economic growth
• Longer term strategies Increasing economic
  growth via capital formation, productivity growth
• Investments in human capital, private sector
  capital, and public sector capital

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A VERY SIMPLE MODEL OF ECONOMIC GROWTH

• Questions where this model provides basic
  insights
• What determines the rate of growth of an economy?
• What is the role of savings and investment?
• How does technological efficiency come into play?
• How does a society become wealthier (or less
  wealthy) over time?

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A VERY SIMPLE MODEL OF ECONOMIC GROWTH

• Questions where this model does not provide
  insights
• What causes fluctuations in economic performance?
• What determines how income is distributed among
  members of society?
• How does this economy react with other national
  economies?
• What does this model tell us about proper
  monetary policy?
• What is the role of government in managing the
  economy?

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A SIMPLE MODEL OF ECONOMIC GROWTH

• Key Variables Yt, Yt1, Kt, It, St
• Y income (or value of production - flow)
• K stock of capital
• I investment (flow)
• S savings (flow)
• Parameters v Capital/Output Ratio
• s propensity to save
• g growth rate (to be derived)

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A SIMPLE MODEL OF ECONOMIC GROWTH (continued)

• Yt 1/vKt reasonable value for v?
• St sYt reasonable value for s?
• Kt1 Kt It
• Solve for Yt1/Yt 1 g
• g s/v warranted rate of growth
• Implications of result?

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THE FUNDAMENTAL ECONOMIC QUESTIONS WHAT EVERY
SOCIETY MUST ADDRESS

• What to produce? gt Composition of GDP
• How to produce it? gt Technology, use of
  resources
• Who does what? gt Mechanisms for the allocation
  of resources
• Who gets what? gt Income and wealth distribution
• How to adapt to change? gt Ability to change the
  dynamic evolution of the economic strategies

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FISCAL AND MONETARY POLICIES

• Tax policies, interest rates, and Federal
  spending
• Should we, as a matter of national policy, pursue
  a balanced budget?
• What are the income distribution, budgetary, and
  growth implications of the Obama 780 billion
  stimulus package?
• What is proper monetary and interest rate policy
  under the current circumstances? How has it
  changed under Bernanke? Are there reasons for us
  to be concerned?
• How have the Iraq and Afghanistan wars affected
  the U.S. economy?

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GLOBALIZATION ISSUES

• Free trade, outsourcing, and future levels of
  income
• On balance, does free trade help or hurt the
  economy?
• Does the Current Accounts deficit pose a threat
  to the economy? If so, in what ways?
• Are we better off with a strong or a weak dollar?
• What are the economic forces underlying
  outsourcing? Are there ethical considerations
  for 1 a day labor in China and India?
• Should we be concerned with the loss of jobs
  because of outsourcing?
• Can and should we address poverty in other
  countries and regions?

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THE BASIC OPTIONS

• Traditional societies gt Decentralized
  primitive stuck in their own set ways unable or
  unwilling to change
• Command economies gt Centralized directed
  challenges of coordination limited by their
  ability to gather and harness information
• Problems with incentives and efficiencies
• Market economies gt Decentralized based on self
  interest, rule of law, protection of contract gt
  excellent at production, not so hot with respect
  to fairness concepts related to distribution

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STABILITY OF ECONOMIC SYSTEMS

• Need for legitimacy if not, political pressures
• Market gt based on contract, rules, and choice
  (restraints placed on the actors), but
  insensitive
• Socialism gt altruism, concern, sympathy,
  solidarity but corruption, inefficiency
• Tradition gt Family values, inflexible
  non-scientific, overwhelmed by other systems
• But markets can deliver efficient growth
  socialism and traditional systems cannot
• A market system can be made more fair protect
  against the arbitrary power of the state

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HOW WELL DOES THE MARKET WORK? HOW WELL CAN IT
DO THE FOLLOWING?

• Delivering the Goods
• Ensuring Justice and Fairness
• Securing the Environment
• Coping with changing Demographics
• Upholding fundamental Societal Values of freedom
  of choice, equal protection under the law,
  equality of opportunity (as well as life,
  liberty, and the pursuit of happiness)

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PARTICULAR OBSERVATIONS

• Look carefully at the Western United States
  versus the Eastern United States
• Note the patterns in Canada, Alaska, central
  South America
• Look at Africa
• Compare the UK to Africa, the Middle East
• Look at Russia, India, China, Japan, North Korea

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GLOBALIZATION QUESTIONS

• Anti-globalists claim there is something
  fundamentally unfair and immoral with a
  globalized economy
• Exploitation of poor countries by rich ones
• Alternatively, there is a need to develop new
  rules to spread the benefits and address the
  downsides
• Note parallels to the beginning of the 20th and
  21st centuries gt Note what happened to the 20th
  century with wars, depressions, nationalism and
  ideology gt Primary reason for the rise of the
  State in the mid-20th century
• Current challenges in Africa, the Middle East gt
  Economic dimensions?

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THE CURRENT ECONOMIC CRISIS HOW DID IT HAPPEN?

• Monetary policy, interest rates, and liquidity
• 1990s The role of technology (the Internet) and
  productivity growth
• 2000s The role of real estate speculation and
  low interest rates
• Portfolio adjustments
• Financial asset bubble in the 1990s Real estate
  bubble from 2000-2006
• Savings rates approached zero. Why?
• Sub-prime mortgages and securitization of loans
• Liar loans
• Using home equity as an ATM machine

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THE CURRENT ECONOMIC CRISIS HOW DID IT HAPPEN?

• The Role of the Current Account Deficit
• Savings rates in China and Japan (and other
  Current Account surplus countries) v. the United
  States
• Citizens of those countries effectively were
  lending to the U.S. to facilitate our spending
• Aggregate Demand
• Total spending by households, by businesses, by
  governments, and by foreign interests gt All
  segments went into decline
• The role of easy credit
• Private debt was very vulnerable to downswings in
  the economy
• Some sectors were overwhelmed by their debt
  obligations due to over-expansion

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QUESTIONS ABOUT THE AMERICAN ECONOMY (or
other national economies)

• Debt and Deficits
• Is private debt a major concern? What are our
  vulnerabilities?
• Do deficits the Federal debt matter? What are
  the implications of the current and future
  situation on interest rates, inflation, economic
  growth, the value of the dollar, and real
  incomes?
• What happened to the projected 4 trillion
  surplus from 2000? What are the implications of
  the deficit that we are encountering now?
• Are we doing the right things to get through the
  current economic crisis? What might we do
  differently?
• How should policy makers deal with the Federal
  budget in the future? Tax increases? Spending
  cuts? No changes?

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DEMOGRAPHIC CHALLENGES

• The Baby Boomer Population Bubble
• Will Social Security and Medicare go insolvent?
  Should they be fundamentally changed?
• How will Americans pay for retirement of Baby
  Boomers?
• What should our immigration policy be?
• Is world population growth a major problem?
• What types of retirement plans should individuals
  have and should the government encourage? What
  is the financial situation of Social Security
  over time?

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THE ROLE OF GOVERNMENT

• What is the appropriate size and role of
  government?
• To what extent does the economy take care of
  itself? How resilient is the American economy?
• How large is the Federal Budget, and what is it
  spent on?
• How does a larger or smaller role of Government
  affect the economy at large?
• Infrastructure, legal, military, public goods
• Regulatory constraints, environmental policies
• Public sector production, income redistribution
• Effects on incentives and economic efficiency

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THE HEALTH CARE CHALLENGE

• What policies should we have regarding health
  care?
• Why has health care become such a large portion
  of the GDP? What does that imply?
• What are the options? Current system, more
  market oriented, universal coverage, single payer
  system, Oregon plan, socialized medicine?
• How do we decide between market options v.
  fundamental rights?

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THE EDUCATION CHALLENGE

• What talents will Americans need to compete in
  the economy of the next 25 years?
• How important is education in a micro and a macro
  context?
• How well is our existing educational system
  working?
• How does education affect the economy? How long
  is the time lag?
• How can we improve upon the quality and quantity
  of education?

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ENERGY

• What are the short term and long term
  implications of current energy sources and
  technological alternatives?
• What has caused the rapid increases in energy
  prices in recent years?
• What caused the oil price spike of 2007-2008?
  How did it compare to the oil price shocks of
  1974, 1979-81, and 1990-91?
• What are the implications for inflation,
  recession, economic performance, or economic
  growth?
• What is likely to occur over the next 10 years?

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FISCAL AND MONETARY ACTIVISM

• How actively should policy-makers be in managing
  the economy and its major variables?
• What are the causes, threats and implications of
• Inflation
• Deflation
• Inadequate aggregate demand
• Structural unemployment

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RIGHTING WRONGS

• What responsibility to we have to address poverty
  and suffering elsewhere in the world?
• Can solving poverty problems enhance the
  likelihood of world peace?
• Proper policies in the Middle East?
• Proper policies in Africa, Latin America?
• Proper policies for lower income and
  disadvantaged in the United States?

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GLOBAL CONCERNS

• How can we address the threats of global warming?
• Where is global population growth going within
  our lifetimes, and what are the implications?
• What responsibilities do we have to the
  well-being of citizens of other parts of the
  world?
• Is Globalization a good or bad thing?

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THE FUTURE

• What is the legacy we are leaving for future
  generations?
• Are we borrowing from future generations to
  finance our spending now (and our retirement
  later?)
• What is the difference between our relationship
  to future generations, and past generations
  relationship to us?
• Will technology serve us well, or destroy us (or
  a bit of both) in the long run?
• Will limited resource supplies constrain future
  growth?