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: 2:00-3:15, Engineering 1104 Instructor: Llad Phillips, Llad@econ.ucsb.edu Office Hours: NH 3032, 9:30-10:15 TuTh and 10:30-11:15 W, and by appointment Arthur O’Sullivan and Steven Sheffrin, Economics, Principles and Tools, Third Edition(2003,2001)

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

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

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 * @ 6.9 % interest Buy The Car, Cash Car’s Services For 1 Yr. Car’s 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 Car’s 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: 24*$302=$7248 • 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 foregone interest on $17,760: $1,225* $2,450 depreciation: $2,813# $4,222 * @ 6.9 % interest $4,038 $6,672 # price+tax-blue book = $17,760 - 0.806*$18,545 Lease, 24 months total drive-off: $2,137 $2,137 total monthly payments @$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.html

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. Monthly Payment? Using Excel 5.0 for a Solution

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

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 & Young’s 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