1. Introduction to Economics Elements of Personal Finance

2. 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

3. Problems O & S Text p. 60: 2, 4, 5, 6 p. 162: 1, 2, 3

4. Econ 109 Class Page • Econ Home Page:http://www.econ.ucsb.edu

5. Announcements • E-mail addresses • Llad Phillips <llad@econ.ucsb.edu> • Donghun Cho<cho@econ.ucsb.edu> • Taeil Kang<kang@econ.ucsb.edu> • Kirk Lesh<lesh@econ.ucsb.edu>

6. 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

7. Chapter 3 Markets and Governmentin the Global Economy

8. 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

9. 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?

10. Major Trading Partnersof the United States, 1999

11. WorldEconomy European Union Japan Mexico Japan US Economy YOU Me

12. 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)

13. Net Worth in 1995 Source: http://www.irs.gov

14. Families: Average Income and Average Net Worth, 1995 Source: Consumer Federation of America

15. Demographics and Per Capita Wealth

16. A Household’s Home Is By Far the Most Frequent Asset http://www.census.gov/hhes/www/wealth/1995/wealth95.html.

17. Net Worth = Assets -Liabilities

18. Assets-Liabilities Statement

19. http://research.stlouisfed.org/fred/data/business/cmdebt

20. http://research.stlouisfed.org/fred/data/business/cdsp

21. Credit Cards Have High Interest Rates On Average: 15-20% You pay 15 % to borrow and you get, currently, 1-2%, to lend

24. 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

25. Part II: Housing Loans, Demand

26. 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

27. Life Cycle Approach: The Planners 100% You 50% Parents 0 % Age Infancy Adolescence Young Adult Adult Senescence

28. 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

29. 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

30. 2000

31. Example for an $80,000 House • price: $80,000 • down payment: $20,000 • loan: $60,000 • interest rate: 10% • loan term: 25 years

32. calculated using TKSOLVER Level Debt Service Module

33. 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

37. Interest Cost • You may not care so much • if you are experiencing capital gains • i.e. the value of the house is rising

38. 1999

40. 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

41. Price, Mortgage Rate Demand for Mortgage Credit 10 % 7 % Quantity of Mortgage Credit

42. Demand for Mortgage Credit Price, Mortgage Rate Higher Personal Income 10 % Quantity of Mortgage Credit

43. 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

44. Price, Mortgage Rate Demand for Mortgage Credit 10 % 7 % Quantity of Mortgage Credit

45. The importance of saving • commitment • discipline • personal income • determinants • managing expenses • income-expense statement • budgeting

46. 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)

47. Determinants of Personal Income The Life Cycle Model

48. 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

49. 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

50. Accumulating Human Capital Inflow Outflow Stock