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Introduction to Economics

Introduction to Economics Elements of Personal Finance Outline: Lecture Three Housing Loans: Interest and Equity Determinants of Personal Income 3. Tuesday, Oct. 6, Lecture Three: "Housing loans; demand for mortgage credit; determinants of personal income"

Gabriel
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Introduction to Economics

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  1. Introduction to Economics Elements of Personal Finance

  2. Outline: Lecture Three • Housing Loans: Interest and Equity • Determinants of Personal Income

  3. 3. Tuesday, Oct. 6, 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: Guide to Understanding Personal Finance, Ch. 3, "Home Finance" O’Sullivan and Sheffrin: Ch.3, “ Markets and Government in the Global Economy” emphasis: comparative advantage and circular flow O’Sullivan and Sheffrin, Appendix to Ch. 7, " Consumer Choice Using Indifference Analysis"

  4. Problems O & S Text p. 56: 1, 2, 3 p. 149: 1, 2, 3

  5. 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

  6. 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

  7. Is Housing a Good Investment for the Nineties? Source: UCSB Economic Forecast Project

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

  9. calculated using TKSOLVER Level Debt Service Module

  10. 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

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

  12. Is Housing a Good Investment for the Nineties? Source: UCSB Economic Forecast Project

  13. 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

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

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

  16. 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

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

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

  19. Determinants of Personal Income The Life Cycle Model

  20. 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

  21. 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

  22. Accumulating Human Capital Inflow Outflow Stock

  23. Accumulating Human Capital Net Inflow Inflow Outflow + Stock -

  24. Accumulating Human Capital Investment Depreciation Learning + Human Capital - Human Capital: An Asset Like a Car or a House: It Depreciates

  25. Allocation of Your Time Build Capital by Learning Human Capital Use Capital for Earning

  26. 24 hours Time Endowment

  27. Leisure (learning) 0 hours 24 hours

  28. Allocation of Your Time Build Capital by Learning Human Capital Use Capital for Earning

  29. 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

  30. Salaries by Education Level, CAFull Time* Workers *Full Time: >35 hrs/wk, >48 wks/yr.; Source: LA Times, 1-10-93

  31. The Rich Get Richer and the Poor Get Poorer • Why does poverty persist in an affluent country like the US?

  32. Comparative market wages as determined by accumulated knowledge Earnings $480 college grad $240 dropout $ 0 Leisure (learning) 0 hours 24 hours

  33. 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?

  34. 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

  35. 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

  36. 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

  37. 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

  38. 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

  39. 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

  40. Why does the youth drop out? • may not like school • may receive bad or no advice • parents • counselors

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

  42. 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

  43. 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

  44. 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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