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Macro Review: ConceptsMacro Review: Concepts

Circular FlowCircular Flow Measure the Size of the EconomyMeasure the Size of the Economy Business CyclesBusiness Cycles GrowthGrowth InflationInflation Money Supply & InflationMoney Supply & Inflation Financial CrisesFinancial Crises Monetary PolicyMonetary Policy

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Circular FlowCircular Flow

Identifies actors: consumers & firmsIdentifies actors: consumers & firms

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Expenditure Perspective: OpenExpenditure Perspective: Open

Firms

Households

SupplyGoods

Demand Goods

Households: Consumption of Goods and ServicesFirms: Investment in Plant and EquipmentGovernment: Purchase of Goods and ServicesAll Three: Exports - Imports = Net Exports

Imports(puchases)

Exports(Sales)

Government

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Size of the EconomySize of the Economy

Expenditures Perspective: GDP & Expenditures Perspective: GDP & ComponentsComponents consumptionconsumption gross investmentgross investment government expendituresgovernment expenditures net exportsnet exports

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Business CyclesBusiness Cycles

Worry: Underutilized ResourcesWorry: Underutilized Resources unemploymentunemployment

Cause: Not enough spendingCause: Not enough spending consumer fear: lack of confidence in economyconsumer fear: lack of confidence in economy business owners fear: lack of consumer demandbusiness owners fear: lack of consumer demand

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Consumption, CInvestment, IGDP

Income, Y

Less than Full Employment Equilibrium

C = C0 + mpc* Y

I

GDP = C + I

450

GDP = Y YFE

Full Employment Income

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Growth in Size of the EconomyGrowth in Size of the Economy

Welfare increases with output per workerWelfare increases with output per worker output per worker increases with:output per worker increases with:

capital deepeningcapital deepening technological progresstechnological progress

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InflationInflation

percentage rate of increase in prices (index)percentage rate of increase in prices (index) price index for a market basket of goods, price index for a market basket of goods,

relative to a base yearrelative to a base year cost of basket in 1998/cost in 1990(base year)cost of basket in 1998/cost in 1990(base year)

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Cause of InflationCause of Inflation

Too much money chasing too few goodsToo much money chasing too few goods Quantity Theory of MoneyQuantity Theory of Money

money supply*velocity = price index*real GDPmoney supply*velocity = price index*real GDP

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Financial CrisesFinancial Crises

Liquidity Crisis: run on the banksLiquidity Crisis: run on the banks Solvency Crisis: bad bank loansSolvency Crisis: bad bank loans

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Monetary PolicyMonetary Policy

GoalsGoals full employmentfull employment price stabilityprice stability interest rate stabilityinterest rate stability

Tools or instrumentsTools or instruments open market operationsopen market operations discount ratediscount rate reserve requirementreserve requirement

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Introduction to EconomicsIntroduction to Economics

MicroeconomicsMicroeconomics

The US EconomyThe US Economy

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Outline: Lecture SixteenOutline: Lecture Sixteen The Distribution of National Income by The Distribution of National Income by

Input Factor SharesInput Factor Shares The Distribution of Personal IncomeThe Distribution of Personal Income Trends in US Income InequalityTrends in US Income Inequality PovertyPoverty

National Income 1996

Employee Compensation

71%

Proprietor's Income9%

Rental Income2%

Corporate Profits11%

Net Interest7%

source: Lecture Six

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US National Income: Factor Shares, 1929-1965 .

0%

20%

40%

60%

80%

100%

29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65Year

Percent

Employee Compensation

Proprietor’s Income

Corporate Profits

Net Interest Rent to Persons

2/3

capital, land, entrepreneurship 1/3

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If workers are paid a real wage equal to If workers are paid a real wage equal to their marginal product of labor,their marginal product of labor,

and other factors of production are paid and other factors of production are paid their marginal product of production,their marginal product of production,

does not everybody get their just desserts?does not everybody get their just desserts?

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Defense of the Status QuoDefense of the Status Quo

If the economy has constant returns to scale,If the economy has constant returns to scale, If labor is paid its marginal product,If labor is paid its marginal product, If capital receives its marginal product,If capital receives its marginal product, Income paid to labor & capital = outputIncome paid to labor & capital = output

Everybody is paid what the are worth and Everybody is paid what the are worth and there is no exploitationthere is no exploitation

MERITOCRACYMERITOCRACY

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Variation of Personal IncomeVariation of Personal Income

The Distribution of IncomeThe Distribution of Income California Income 1993California Income 1993

Number of tax returns by adjusted gross income Number of tax returns by adjusted gross income (AGI) class(AGI) class

US IncomeUS Income

California: Adjusted Gross Income, 1993 Tax Year .

0

50000

100000

150000

200000

250000

300000

0

20004000600080001000012000140001600018000200002200024000260002800030000

Adjusted Gross Income .

Number

Source: California Statsitical Abstract

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California: Number of Returns by Adjusted Gross Income, . Tax Year 1993

0

500000

1000000

1500000

2000000

2500000

3000000

10000 20000 30000 40000 50000 60000 70000 80000 90000100000

Adjusted Gross Income .

Number

CA AGI, Frequency & Cumulative FrequencyCA AGI, Frequency & Cumulative FrequencyIncome Number Frequency Cumulative

< 10,000 2727672 22.86% 22.8610-20,000 2440167 20.45% 43.31

20-30,000 1802873 15.11% 58.42 30-40,000 1305679 10.94% 69.36

-50,000 997933 8.37% 77.73 -100,000 2107160 17.66% 95.39 -150,000 323390 2.71% 98.10 -200,000 102863 0.86% 98.96 -300,000 70848 0.59% 99.55 -400,000 23982 0.20% 99.75 -500,000 11661 0.10% 99.85

-1,000,000 17172 0.14% 99.99

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Distribution of Adjusted Gross Income, California .

0

0.05

0.1

0.15

0.2

0.25

0

10000 20000 30000 40000 50000 60000 70000 80000 90000100000

Income

Frequency

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Cumulative Distribution of California Adjusted Gross Income .

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

5000100001500020000250003000035000400005000060000700008000090000

1000001500002000003000004000005000001000000

Income

Probability

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Measures of Income InequalityMeasures of Income Inequality Lorenz CurveLorenz Curve

What % of Population Has What % of IncomeWhat % of Population Has What % of Income Gini CoefficientGini Coefficient

• range: 0, meaning equal, to 1, meaning unequal range: 0, meaning equal, to 1, meaning unequal

ExamplesExamples socialist ideal: equalitysocialist ideal: equality life as a crap shoot: any income is equally likelylife as a crap shoot: any income is equally likely

% Population % Income0 0

20 2040 4060 6080 8095 95

100 100

Frequency for Equal Distribution of Income .

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

0

5000100001500020000250003000035000400004500050000550006000065000700007500080000850009000095000

100000Income

frequency

Lorenz Curve: Equal Distribution of Income .

0

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100

% Population

% Income

$33000

Cumulative Frequency: Equal Distribution .

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0

5000100001500020000250003000035000400004500050000550006000065000700007500080000850009000095000

100000Income

Probability

% Population Uniform0 0

20 440 1660 3680 6495 90.25

100 100

Frequency Distribution for the Uniform .

0

0.002

0.004

0.006

0.008

0.01

0

80001600024000320004000048000560006400072000800008800096000

Income

Frequency

Cumulative Frequency for Uniform Distribution .

0

0.2

0.4

0.6

0.8

1

0

700014000210002800035000420004900056000630007000077000840009100098000

Income

Probability

Lorenz Curve for Uniform Distribution .

0

20

40

60

80

100

0 20 40 60 80 100

% Population

% Income

Gini Coefficient = A/(A+B)

AB

% Families % Income0 020 4.240 14.260 29.980 53.295 79.9

100 100

US Family Income, 1994

Lorenz Curve: United States Families, 1994 .

0

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100

% Families

% Income

Equal

Uniform

Family

Source: US Statistical Abstract

Frequency Distribution for the Exponential . .

0

0.005

0.01

0.015

0.02

0.025

0.03

0

5000100001500020000250003000035000400004500050000550006000065000700007500080000850009000095000

Income

Frequency

Cumulative Frequency for Exponential .

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0

5000100001500020000250003000035000400004500050000550006000065000700007500080000850009000095000

100000Income

Probability

Lorenz Curve: Exponential Distribution .

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0 0.2 0.4 0.6 0.8 1

Percent Population

Percent Income

% POP % Income0 0

0.09516258 0.004678840.18126925 0.01752310.22119922 0.026499020.32967995 0.061551940.39346934 0.090204010.52763345 0.173358530.63212056 0.264241120.77686984 0.44217460.86466472 0.593994150.95021293 0.800851730.98168436 0.90842181

1 1

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Distribution of Adjusted Gross Income, California .

0

0.05

0.1

0.15

0.2

0.25

0

10000 20000 30000 40000 50000 60000 70000 80000 90000100000

Income

Frequency

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Why is Income Distributed So Unevenly?Why is Income Distributed So Unevenly? Labor Income is Unevenly DistributedLabor Income is Unevenly Distributed Part-time workPart-time work

less than 50 weeks per yearless than 50 weeks per year less than 36 hours per weekless than 36 hours per week

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“A rising tide lifts all boats”, JFK“A rising tide lifts all boats”, JFK Economic growth may make everbody Economic growth may make everbody

better offbetter off increases the size of the pieincreases the size of the pie

but the rich may get a larger share of the bigger piebut the rich may get a larger share of the bigger pie

It is possible that the rich get richer and the It is possible that the rich get richer and the poor get poorerpoor get poorer

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Income Distribution and GDP Per CapitaIncome Distribution and GDP Per Capita

Country GDP PerCapita,1990*

Income Share:Lowest 40%,Families

GiniCoefficient

Singapore $15,580 15% 0.42HongKong

$15,595 16.2% 0.45

Malaysia $6,140 13.9% 0.48Mexico $5,918 0.50Brazil $4,718 8.1% 0.57Jamaica $2,979 15.3% 0.66Honduras $1,470 0.62

* purchasing power parity

Source: United Nations Development Programme, Human Development Report, 1993

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Lorenz Curves: US Famiy Income, 1970, 1980, 1994 . .

0

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100

% Families

% Income

1970

1980

1994

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Trends In US Family Income Shares, . Top 5%, Top 20%, Bottom 40%

0

5

10

15

20

25

30

35

40

45

50

1970 1975 1980 1985 1990 1995

% Families

% Income

Top 5 %

Top 20 %

Bottom 40%

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Trends In US Median Family Income, 1994 $ .

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1970 1975 1980 1985 1990 1995

Year

1994 $

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Why has income become more unevenly distributed?Why has income become more unevenly distributed? Standardize on Male Full-Time Year-Around WorkersStandardize on Male Full-Time Year-Around Workers Ability PremiumAbility Premium

90 percentile: $70314 for 1995 males90 percentile: $70314 for 1995 males 50 percentile: $3149750 percentile: $31497 10 percentile: $1292010 percentile: $12920

Education PremiumEducation Premium college grads gain relative to high school gradscollege grads gain relative to high school grads

Experience PremiumExperience Premium older workers gain relative to younger workersolder workers gain relative to younger workers

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Earnings Ratios for Male High School Graduates .

0

0.5

1

1.5

2

2.5

1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995Year

Ratio

90/50 ratio

50/10 ratio

Source: Economic Report of the President, 1997

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Ratio of Median Earnings, Males: College Grad to High School Grad

Source: Economic Report of the President, 1997

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Ratio of Median Earnings, Males: Age 45-54 to 25-34

Source: Economic Report of the President, 1997

Llad Phillips 40Source: Economic Report of the President, 1997

Growing Wage Differentials Between the Less Skilled and More Skilled:Less Demand for Less Skilled and More Demand for the More Skilled

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Rich Are Getting Richer Rich Are Getting Richer

smart are getting richersmart are getting richer educated are getting richereducated are getting richer experienced are getting richerexperienced are getting richer

Should we worry about the dull, the Should we worry about the dull, the ignorant, the young and inexperienced?ignorant, the young and inexperienced?

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Poverty in the USPoverty in the US US Government Definition of PovertyUS Government Definition of Poverty

Subsistence wage: $15141 in 1994Subsistence wage: $15141 in 1994 a non-farm family of foura non-farm family of four cost of inexpensive but nutritious food times 3cost of inexpensive but nutritious food times 3

• assume food is 1/3 of budgetassume food is 1/3 of budget

Trends in PovertyTrends in Poverty Incidence of PovertyIncidence of Poverty

elderlyelderly children/families headed by single womenchildren/families headed by single women ruralrural

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Incidence of Poverty Among the Aged and the YoungChildren: 14.9% in 1970 to 21.2% in 1994

Source: Economic Report of the President, 1997

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Percentage of Births Occuring Out of Wedlock, . White Women by Age Group, US .

0

5

10

15

20

25

30

35

1955 1960 1965 1970 1975 1980

Year

Percent

15-19

20-24

25-29

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Percentage of Births Occurring Out of Wedlock, . Black Mothers By Age Group, US

0

10

20

30

40

50

60

70

80

90

1955 1960 1965 1970 1975 1980

Year

Percent

15-19

20-24

25-29

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US Families Headed By Women in Percent .

0

5

10

15

20

25

30

35

40

45

1940 1950 1960 1970 1983

Year

Percent

White

Black

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Marriage and Divorce Rates Per 1000 Population, US .

0

2

4

6

8

10

12

1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992Year

Rate

Marriages

Divorces

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US Marrige Rates Per 1000 Population, . Unmarried Women 15-44 Years Old

0

20

40

60

80

100

120

140

160

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994Year

Rate

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Summary-Vocabulary-ConceptsSummary-Vocabulary-Concepts input factor sharesinput factor shares distribution of distribution of

personal incomepersonal income distribution of family distribution of family

incomeincome frequency distribution frequency distribution

of incomeof income cumulative cumulative

distribution of incomedistribution of income Lorenz curveLorenz curve Gini coefficientGini coefficient median family incomemedian family income

part-time, part-year part-time, part-year workerworker

full-time, full-year full-time, full-year workerworker

within group variation within group variation in earningsin earnings

ability differentialability differential between group between group

variation in earningsvariation in earnings education differentialeducation differential experience differentialexperience differential definition of povertydefinition of poverty