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Introduction to Economics Elements of Personal Finance 3. Thursday, Oct. 3, Lecture Three: "Housing loans; demand for mortgage credit; determinants of personal income" Housing loans: interest and equity demand for mortgage credit Determinants of personal income

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Introduction to economics l.jpg

Introduction to Economics

Elements of Personal Finance


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3. Thursday, Oct. 3, Lecture Three: "Housing loans; demand for

mortgage credit; determinants of personal income"

Housing loans: interest and equity

demand for mortgage credit

Determinants of personal income

tastes for leisure and income

Reading Assignment:

O’Sullivan and Sheffrin: Ch.3, “ Markets in

the Global Economy”

emphasis: comparative advantage and circular flow

O’Sullivan and Sheffrin, Appendix to Ch. 7, " Consumer

Choice Using Indifference Curves”, pp. 155-162

Internet Resource: http://www.mortgage101.com


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Problems O & S Text for

p. 60: 2, 4, 5, 6

p. 162: 1, 2, 3


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Econ 109 Class Page for

  • Econ Home Page:http://www.econ.ucsb.edu


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Announcements for


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Concepts for

  • Lecture: Assets, Liabilities, Net Worth

  • Lecture: Demand for Housing Loans

  • Lecture: The Importance of Saving

  • Lecture: Learning and Earning

  • Text: Markets, the Magic and the Mantra


Markets and government in the global economy l.jpg

Chapter 3 for

Markets and Governmentin the Global Economy


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Markets as a Social Institution for

  • Adam Smith: The Wealth of Nations(1776)

    • argues for free markets and free exchange

  • Markets allocate resources so supply meets demand

  • If markets are competitive, thenthe value that the last consumer entering the market is willing to pay equals the additional cost of producing one more unit of the good

    • this is the magic of markets: efficiency

  • The political mantra is that markets solve all problems: false if there is monopoly power


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Current Economic Events for

  • Labor Dispute between the shipping association and the longshoremen

    • lockout

    • cost to the economy: $1 B per day

  • What is at stake?


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Major Trading Partners for of the United States, 1999


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World for Economy

European

Union

Japan

Mexico

Japan

US Economy

YOU

Me


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Part I: Wealth (Net Worth) and Debt for

  • Personal Wealth

    • a million millionaires

    • ordering the population form the poorest fifth to the richest fifth by income and net worth

    • the home is the big ticket asset

  • Liabilities: credit card debt

    • consumer debt service as a % of personal disposable income (after taxes)


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Net Worth in 1995 for

Source: http://www.irs.gov


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Families: Average Income and Average Net Worth, 1995 for

Source: Consumer Federation of America



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A Household’s Home Is By Far the Most Frequent Asset for

http://www.census.gov/hhes/www/wealth/1995/wealth95.html.






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Credit Cards Have High Interest Rates On Average: 15-20% for

You pay 15 % to borrow and you get, currently, 1-2%, to lend


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Planning Tools for

  • Assets-Liabilities Statement

    • Assets Minus Liabilities = Net Worth

      • measure of wealth

  • Income-Expenditure Statement

    • Income Minus Expenditures = Saving

      • measure of change in wealth



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Life Cycle Approach: Planning for

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


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Life Cycle Approach: The Planners for

100%

You

50%

Parents

0 %

Age

Infancy

Adolescence

Young Adult

Adult

Senescence


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Strategies for Meeting Future Expenses for

  • Buy a House

    • most valuable asset for most US households

    • commitment to monthly payment

  • Tax-Sheltered Savings Plans

    • commitment to monthly payment

  • Stocks and Bonds


Buying a house l.jpg

Positives for

provides space

builds equity

interest is deductible

Negatives?

down payment requires saving for this goal

interest payments are front-loaded, equity growth delayed

opportunity cost of not investing in stocks

Buying a House


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2000 for


Example for an 80 000 house l.jpg
Example for an $80,000 House for

  • price: $80,000

  • down payment: $20,000

  • loan: $60,000

  • interest rate: 10%

  • loan term: 25 years


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calculated using for TKSOLVER Level Debt Service Module


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Slow Growth In Equity for

  • Interest is front loaded

  • Start with $20,000 equity in example

  • After 10 years, gained about $10,000 equity

  • After 20 years, gained about $35,000 equity

  • Last 5 years, gain last $25,000 in equity

    • less interest payments for tax deductions

    • may not want to refinance, since you are paying off principal


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Interest Cost for

  • You may not care so much

    • if you are experiencing capital gains

      • i.e. the value of the house is rising


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1999 for


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Demand for Housing Loans for

  • You are more likely to buy a house if the mortgage rate is low

    • your behavior is sensitive to the national economy

  • More people will be buying houses and demanding mortgage credit if the mortgage rate is low

  • More people will be buying houses and demanding mortgages if their income is rising

    • they can afford a higher monthly payment and a lower loan term


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Price, for

Mortgage

Rate

Demand for Mortgage Credit

10 %

7 %

Quantity of Mortgage Credit


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Demand for Mortgage Credit for

Price,

Mortgage

Rate

Higher Personal Income

10 %

Quantity of Mortgage Credit


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Expressing The Demand For Mortgage Credit for

1. Words

Quantity of Mortgage Credit Mortgage Rate, Personal

Income

2. Symbols

Q = f(r, Y)

rule of correspondence: if you know the mortgage

rate, r, and if you know personal income, Y, then you

can determine the demand for mortgage credit, Q

3. Pictures

r

Q


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Price, for

Mortgage

Rate

Demand for Mortgage Credit

10 %

7 %

Quantity of Mortgage Credit


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The importance of saving for

  • commitment

    • discipline

  • personal income

    • determinants

  • managing expenses

    • income-expense statement

      • budgeting


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Part III: Learning and Earning, the Human Capital Story for

  • Stocks

    • assets

    • debts

    • net worth(wealth)

  • Flows

    • income

    • saving (this flow is the increase inyour wealth)


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Determinants of Personal Income for

The Life Cycle Model


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An Individual’s Life Cycle for a for Socially Productive Life

  • Learning over the life cycle

  • Accumulating earning power or human capital

  • Earnings depend upon

    • ability

    • knowledge

    • work experience


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Productive Life Cycle for

Social Institution

Family - PreSchool - School - College - Job - Retirement

Function

Learning: Accum. Human Capital - Earning - Spending

Age Line

0 4 6 18 23 65


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Accumulating Human Capital for

Inflow

Outflow

Stock


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Accumulating Human Capital for

Net Inflow

Inflow

Outflow

+

Stock

-


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Accumulating Human Capital for

Investment

Depreciation

Learning

+

Human

Capital

-

Human Capital: An Asset Like a Car or a House:

It Depreciates


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Allocation of Your Time for

Build Capital

by Learning

Human Capital

Use Capital

for Earning


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24 hours for

Time Endowment


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Leisure for

(learning)

0 hours

24 hours


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Allocation of Your Time for

Build Capital

by Learning

Human Capital

Use Capital

for Earning


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Earnings for

Opportunities for trading leisure

for earnings (income) at a rate,

$20 per hour, the market wage,

determined by your stock of human

capital(step one of the paradigm:

describing the alternatives for choice)

$480

$ 0

Leisure

(learning)

0 hours

24 hours


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Salaries by Education Level, CA for Full Time* Workers

*Full Time: >35 hrs/wk, >48 wks/yr.; Source: LA Times, 1-10-93


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The Rich Get Richer and the Poor Get Poorer for

  • Why does poverty persist in an affluent country like the US?


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Comparative market wages as determined by accumulated for

knowledge

Earnings

$480

college grad

$240

dropout

$ 0

Leisure

(learning)

0 hours

24 hours


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Choosing Between Learning and Earning for

  • How much time for learning?

  • How much time for earning?

  • This choice, like all choices depends on your tastes

    • Do you want to earn and consume now?

    • Do you want to learn, earn more in the future, and consume more in the future?


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Depicting your tastes graphically: iso-preference or for

indifference curves

Earnings

Iso-Preference Curves:

You value all points on

a curve equally(step two of

the paradigm: valuing the

alternatives for choice)

$480

$ 0

Leisure

(learning)

24 hours

0 hours


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Depicting your tastes graphically for

Earnings

low value

Iso-Preference Curves:

You value all points on

a curve equally

high

$480

high value

$ 0

Leisure

(learning)

0 hours

24 hours


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The choice between leisure and earning now:picking the for

best alternative

Earnings

Iso-Preference Curves:

You value all points on

a curve equally

high

$480

alternatives

high value

low value

$ 0

Leisure

(learning)

0 hours

24 hours


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Individual’s Supply of Labor for

Earnings

low value

high

$480

Optimum

$180

for 9 hrs

of work

high value

Leisure

(learning)

$ 0

15 hours

of leisure

0 hours

24 hours


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Earnings for

low value

slope of the iso-preference

curve through the 24 hour

endowment is the lowest

wage at which you are

willing to work

high

$480

$ 0

Leisure

(learning)

0 hours

24 hours


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Earnings for

low value

slope of the iso-preference

curve through the 24 hour

endowment is the lowest

wage at which you are

willing to work

high

$480

$96

$ 0

Leisure

(learning)

0 hours

24 hours

dropout is unwilling to work for $4/hr


Why does the youth drop out l.jpg
Why does the youth drop out? for

  • may not like school

  • may receive bad or no advice

    • parents

    • counselors


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Life Cycle Approach: The Planners for

100%

You

50%

Parents

0 %

Age

Infancy

Adolescence

Young Adult

Adult

Senescence


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Participation in the Labor Force: for Willing to look for work

  • If your market wage exceeds your reservation wage

    • college grad, @$20/hr, participates

    • the junior high dropout, @ $4/hr, does not

  • We assumed the college grad and the dropout both have the same values for income and leisure

  • Only their learning histories differ


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Earnings for

low value

slope of the iso-preference

curve through the 24 hour

endowment is the lowest

wage at which you are

willing to work

high

$480

$96

$ 0

Leisure

(learning)

0 hours

24 hours

dropout is unwilling to work for $4/hr


Slide72 l.jpg

low value for

Higher value

high

$480

Savings,

$ from

home

$96

$ 0

0 hours

24 hours


Summary vocabulary concepts l.jpg

median for

demand curve

mortgage rate

personal income

mortgage credit

rule of correspondence

stock

inflow

outflow

time endowment

allocation of your time

learning(leisure)

earning in future

earning now

iso-preference curves

reservation wage

Summary-Vocabulary-Concepts


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