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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

Introduction to Economics

Elements of Personal Finance

slide2
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

slide3
Problems O & S Text

p. 60: 2, 4, 5, 6

p. 162: 1, 2, 3

econ 109 class page
Econ 109 Class Page
  • Econ Home Page:http://www.econ.ucsb.edu
announcements
Announcements
  • E-mail addresses
    • Llad Phillips
    • Donghun Cho
    • Taeil Kang
    • Kirk Lesh
concepts
Concepts
  • 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 as a social institution
Markets as a Social Institution
  • 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
current economic events
Current Economic Events
  • Labor Dispute between the shipping association and the longshoremen
    • lockout
    • cost to the economy: $1 B per day
  • What is at stake?
slide11
WorldEconomy

European

Union

Japan

Mexico

Japan

US Economy

YOU

Me

part i wealth net worth and debt
Part I: Wealth (Net Worth) and Debt
  • 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)
net worth in 1995
Net Worth in 1995

Source: http://www.irs.gov

families average income and average net worth 1995
Families: Average Income and Average Net Worth, 1995

Source: Consumer Federation of America

slide16
A Household’s Home Is By Far the Most Frequent Asset

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

slide21
Credit Cards Have High Interest Rates On Average: 15-20%

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

planning tools
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
slide26
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

slide27
Life Cycle Approach: The Planners

100%

You

50%

Parents

0 %

Age

Infancy

Adolescence

Young Adult

Adult

Senescence

strategies for meeting future expenses
Strategies for Meeting Future Expenses
  • 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
Positives

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
example for an 80 000 house
Example for an $80,000 House
  • price: $80,000
  • down payment: $20,000
  • loan: $60,000
  • interest rate: 10%
  • loan term: 25 years
slow growth in equity
Slow Growth In Equity
  • 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
interest cost
Interest Cost
  • You may not care so much
    • if you are experiencing capital gains
      • i.e. the value of the house is rising
demand for housing loans
Demand for Housing Loans
  • 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
slide41
Price,

Mortgage

Rate

Demand for Mortgage Credit

10 %

7 %

Quantity of Mortgage Credit

slide42
Demand for Mortgage Credit

Price,

Mortgage

Rate

Higher Personal Income

10 %

Quantity of Mortgage Credit

slide43
Expressing The Demand For Mortgage Credit

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

slide44
Price,

Mortgage

Rate

Demand for Mortgage Credit

10 %

7 %

Quantity of Mortgage Credit

the importance of saving
The importance of saving
  • commitment
    • discipline
  • personal income
    • determinants
  • managing expenses
    • income-expense statement
      • budgeting
part iii learning and earning the human capital story
Part III: Learning and Earning, the Human Capital Story
  • Stocks
    • assets
    • debts
    • net worth(wealth)
  • Flows
    • income
    • saving (this flow is the increase inyour wealth)
an individual s life cycle for a socially productive life
An Individual’s Life Cycle for a Socially Productive Life
  • Learning over the life cycle
  • Accumulating earning power or human capital
  • Earnings depend upon
    • ability
    • knowledge
    • work experience
slide49
Productive Life Cycle

Social Institution

Family - PreSchool - School - College - Job - Retirement

Function

Learning: Accum. Human Capital - Earning - Spending

Age Line

0 4 6 18 23 65

slide50
Accumulating Human Capital

Inflow

Outflow

Stock

slide51
Accumulating Human Capital

Net Inflow

Inflow

Outflow

+

Stock

-

slide52
Accumulating Human Capital

Investment

Depreciation

Learning

+

Human

Capital

-

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

It Depreciates

slide53
Allocation of Your Time

Build Capital

by Learning

Human Capital

Use Capital

for Earning

slide54
24 hours

Time Endowment

slide55
Leisure

(learning)

0 hours

24 hours

slide56
Allocation of Your Time

Build Capital

by Learning

Human Capital

Use Capital

for Earning

slide57
Earnings

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

salaries by education level ca full time workers
Salaries by Education Level, CAFull Time* Workers

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

the rich get richer and the poor get poorer
The Rich Get Richer and the Poor Get Poorer
  • Why does poverty persist in an affluent country like the US?
slide60
Comparative market wages as determined by accumulated

knowledge

Earnings

$480

college grad

$240

dropout

$ 0

Leisure

(learning)

0 hours

24 hours

choosing between learning and earning
Choosing Between Learning and Earning
  • 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?
slide62
Depicting your tastes graphically: iso-preference or

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

slide63
Depicting your tastes graphically

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

slide64
The choice between leisure and earning now:picking the

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

slide65
Individual’s Supply of Labor

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

slide66
Earnings

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

slide67
Earnings

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
Why does the youth drop out?
  • may not like school
  • may receive bad or no advice
    • parents
    • counselors
slide69
Life Cycle Approach: The Planners

100%

You

50%

Parents

0 %

Age

Infancy

Adolescence

Young Adult

Adult

Senescence

participation in the labor force willing to look for work
Participation in the Labor Force: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
slide71
Earnings

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
low value

Higher value

high

$480

Savings,

$ from

home

$96

$ 0

0 hours

24 hours

summary vocabulary concepts
median

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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