Macro Review: Concepts
Circular Flow
 Measure the Size of the Economy
 Business Cycles
 Growth
 Inflation
 Money Supply & Inflation
 Financial Crises
 Monetary Policy
Llad Phillips

1
Circular Flow

Identifies actors: consumers & firms
Llad Phillips
2
Expenditure Perspective: Open
Firms
Exports
(Sales)
Supply
Goods
Demand
Goods
Imports
(puchases)
Households
Government
Households: Consumption of Goods and Services
Firms: Investment in Plant and Equipment
Government: Purchase of Goods and Services
All Three: Exports - Imports = Net Exports
Llad Phillips
3
Size of the Economy

Expenditures Perspective: GDP &
Components
 consumption
 gross
investment
 government expenditures
 net exports
Llad Phillips
4
Business Cycles

Worry: Underutilized Resources
 unemployment

Cause: Not enough spending
 consumer
fear: lack of confidence in economy
 business owners fear: lack of consumer demand
Llad Phillips
5
Less than Full Employment Equilibrium
Consumption, C
GDP = C + I
Investment, I
GDP
C = C0 + mpc* Y
I
450
GDP = Y
Llad Phillips
Full Employment Income
YFE
Income, Y
6
Growth in Size of the Economy
Welfare increases with output per worker
 output per worker increases with:

 capital
deepening
 technological progress
Llad Phillips
7
Inflation
percentage rate of increase in prices (index)
 price index for a market basket of goods,
relative to a base year

 cost
Llad Phillips
of basket in 1998/cost in 1990(base year)
8
Cause of Inflation
Too much money chasing too few goods
 Quantity Theory of Money

 money
Llad Phillips
supply*velocity = price index*real GDP
9
Financial Crises
Liquidity Crisis: run on the banks
 Solvency Crisis: bad bank loans

Llad Phillips
10
Monetary Policy

Goals
 full
employment
 price stability
 interest rate stability

Tools or instruments
 open
market operations
 discount rate
 reserve requirement
Llad Phillips
11
Introduction to Economics
Microeconomics
The US Economy
Llad Phillips
12
Outline: Lecture Sixteen
The Distribution of National Income by
Input Factor Shares
 The Distribution of Personal Income
 Trends in US Income Inequality
 Poverty

Llad Phillips
13
National Income 1996
Corporate Profits
Rental Income11%
Net Interest
7%
2%
Proprietor's Income
9%
Employee
Compensation
71%
source: Lecture Six
US National Income: Factor Shares, 1929-1965
.
Rent to Persons
Net Interest
100%
Corporate Profits
80%
Proprietor’s Income
40%
Employee Compensation
2/3
capital, land, entrepreneurship
1/3
20%
Year
Llad Phillips
15
65
63
61
59
57
55
53
51
49
47
45
43
41
39
37
35
33
31
0%
29
Percent
60%
If workers are paid a real wage equal to
their marginal product of labor,
 and other factors of production are paid
their marginal product of production,
 does not everybody get their just desserts?

Llad Phillips
16
Defense of the Status Quo
If the economy has constant returns to scale,
 If labor is paid its marginal product,
 If capital receives its marginal product,
 Income paid to labor & capital = output

Everybody is paid what the are worth and
there is no exploitation
 MERITOCRACY

Llad Phillips
17
Variation of Personal Income

The Distribution of Income
 California
Income 1993
 Number
of tax returns by adjusted gross income
(AGI) class
 US
Llad Phillips
Income
18
California: Adjusted Gross Income, 1993 Tax Year
.
300000
250000
150000
100000
50000
Adjusted Gross Income
Source: California Statsitical Abstract
.
30000
28000
26000
24000
22000
20000
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
0
Number
200000
California: Number of Returns by Adjusted Gross Income,
T ax Year 1993
.
3000000
2500000
1500000
1000000
500000
Adjusted Gross Income
Llad Phillips
100000
90000
80000
70000
60000
50000
40000
30000
20000
0
10000
Number
2000000
.
20
CA AGI, Frequency & Cumulative Frequency
Income
< 10,000
10-20,000
20-30,000
30-40,000
-50,000
-100,000
-150,000
-200,000
-300,000
-400,000
-500,000
-1,000,000
Number Frequency Cumulative
2727672
22.86%
22.86
2440167
20.45%
43.31
1802873
15.11%
58.42
1305679
10.94%
69.36
997933
8.37%
77.73
2107160
17.66%
95.39
323390
2.71%
98.10
102863
0.86%
98.96
70848
0.59%
99.55
23982
0.20%
99.75
11661
0.10%
99.85
17172
0.14%
99.99
Distribution of Adjusted Gross Income, California .
0.25
0.15
0.1
0.05
100000
90000
80000
70000
60000
50000
40000
30000
20000
10000
0
0
Frequency
0.2
Income
Llad Phillips
22
Llad Phillips
Income
23
1000000
500000
400000
300000
200000
150000
100000
90000
80000
70000
60000
50000
40000
35000
30000
25000
20000
15000
10000
5000
Probability
Cumulative Distribution of California Adjusted Gross Income
.
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Measures of Income Inequality

Lorenz Curve
 What
% of Population Has What % of Income
 Gini
Coefficient
• range: 0, meaning equal, to 1, meaning unequal

Examples
 socialist
ideal: equality
 life as a crap shoot: any income is equally likely
Llad Phillips
24
Frequency for Equal Distribution of Income .
Cumulative Frequency: Equal Distribution
0.1
1
0.09
0.9
$33000
0.08
0.07
0.8
0.7
0.06
0.05
Probability
0.04
0.03
0.6
0.5
0.4
0.02
0.3
0.01
0.2
0.1
100000
100000
95000
90000
85000
80000
75000
70000
65000
60000
55000
50000
45000
40000
35000
30000
25000
20000
15000
Income
10000
0
0
95000
90000
85000
80000
75000
70000
65000
60000
55000
50000
45000
40000
35000
30000
25000
20000
15000
10000
0
5000
0
5000
frequency
.
Income
Lorenz Curve: Equal Distribution of Income
.
100
0
20
40
60
80
95
100
% Income
90
0
20
40
60
80
95
100
80
70
% Income
% Population
60
50
40
30
20
10
0
0
20
40
% Population
60
80
100
Frequency Distribution for the Uniform .
Cumulative Frequency for Uniform Distribution
1
0.01
0.8
Probability
0.008
0.006
0.004
0.002
0
0.6
0.4
0.2
Income
0
20
40
60
80
95
100
98000
91000
84000
77000
70000
63000
56000
49000
Income
Uniform
Lorenz Curve for Uniform Distribution
0
4
16
36
64
90.25
100
.
100
Gini Coefficient = A/(A+B)
80
% Income
% Population
42000
35000
28000
21000
14000
0
96000
88000
80000
72000
64000
56000
48000
40000
32000
24000
16000
8000
0
0
7000
Frequency
.
60
A
40
B
20
0
0
20
40
60
% Population
80
100
US Family Income, 1994
% Families % Income
0
0
20
4.2
40
14.2
60
29.9
80
53.2
95
79.9
100
100
Lorenz Curve: United States Families, 1994
.
100
90
80
% Income
70
60
50
40
30
Equal
Uniform
Family
20
10
0
0
Source: US Statistical Abstract
20
40
60
% Families
80
100
Frequency Distribution for the Exponential
. .
Cumulative Frequency for Exponential
0.03
.
1
0.9
0.025
0.8
Probability
0.7
0.015
0.01
0.6
0.5
0.4
0.3
0.005
0.2
0.1
95000
% POP
0
0.00467884
0.0175231
0.02649902
0.06155194
0.09020401
0.17335853
0.26424112
0.4421746
0.59399415
0.80085173
0.90842181
1
100000
95000
90000
85000
80000
75000
70000
65000
60000
55000
Lorenz Curve: Exponential Distribution
.
1
0.9
0.8
0.7
Percent Income
0.09516258
0.18126925
0.22119922
0.32967995
0.39346934
0.52763345
0.63212056
0.77686984
0.86466472
0.95021293
0.98168436
50000
Income
% Income
0
45000
40000
35000
30000
25000
20000
15000
10000
Income
5000
0
0
90000
85000
80000
75000
70000
65000
60000
55000
50000
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
0
Frequency
0.02
0.6
0.5
0.4
0.3
0.2
0.1
0
1
0
0.2
0.4
0.6
Percent Population
0.8
1
Distribution of Adjusted Gross Income, California .
0.25
0.15
0.1
0.05
100000
90000
80000
70000
60000
50000
40000
30000
20000
10000
0
0
Frequency
0.2
Income
Llad Phillips
29
Why is Income Distributed So
Unevenly?
Labor Income is Unevenly Distributed
 Part-time work

 less
than 50 weeks per year
 less than 36 hours per week
Llad Phillips
30
“A rising tide lifts all boats”, JFK

Economic growth may make everbody
better off
 increases
 but

the size of the pie
the rich may get a larger share of the bigger pie
It is possible that the rich get richer and the
poor get poorer
Llad Phillips
31
Income Distribution and GDP Per Capita
Source: United Nations Development Programme, Human Development Report, 1993
Country
GDP Per Income Share: Gini
Capita, Lowest 40%, Coefficient
1990*
Families
Singapore
Hong
Kong
Malaysia
Mexico
Brazil
Jamaica
Honduras
$15,580
$15,595
15%
16.2%
0.42
0.45
$6,140
$5,918
$4,718
$2,979
$1,470
13.9%
0.48
0.50
0.57
0.66
0.62
8.1%
15.3%
* purchasing power parity
Llad Phillips
32
.
Lorenz Curves: US Famiy Income, 1970, 1980, 1994
.
100
90
80
% Income
70
60
50
40
30
1970
1980
1994
20
10
0
0
20
40
60
80
100
% Families
Llad Phillips
33
Trends In US Family Income Shares, .
Top 5%, Top 20%, Bottom 40%
50
45
40
% Income
35
30
25
20
15
10
5
Top 5 %
Top 20 %
Bottom 40%
0
1970
1975
1980
1985
1990
1995
% Families
Llad Phillips
34
Trends In US Median Family Income, 1994 $
.
45000
40000
35000
1994 $
30000
25000
20000
15000
10000
5000
0
1970
1975
1980
1985
1990
1995
Year
Llad Phillips
35
Why has income become more
unevenly distributed?
Standardize on Male Full-Time YearAround Workers
 Ability Premium

 90
percentile: $70314 for 1995 males
 50 percentile: $31497
 10 percentile: $12920

Education Premium
 college

grads gain relative to high school grads
Experience Premium
36
older workers gain relative to younger workers
Llad Phillips

Earnings Ratios for Male High School Graduates
.
2.5
2
Ratio
1.5
1
90/50 ratio
50/10 ratio
0.5
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
0
Year
Llad Phillips
Source: Economic Report of the President, 1997
37
Ratio of Median Earnings, Males: College Grad to High School Grad
Source: Economic Report of the President, 1997
Llad Phillips
38
Ratio of Median Earnings, Males: Age 45-54 to 25-34
Llad Phillips
Source: Economic Report of the President, 1997
39
Growing Wage Differentials Between the Less Skilled and More Skilled:
Less Demand for Less Skilled and More Demand for the More Skilled
Llad Phillips
Source: Economic Report of the President, 1997
40
Rich Are Getting Richer
smart are getting richer
 educated are getting richer
 experienced are getting richer


Should we worry about the dull, the
ignorant, the young and inexperienced?
Llad Phillips
41
Poverty in the US

US Government Definition of Poverty
 Subsistence
wage: $15141 in 1994
a
non-farm family of four
 cost of inexpensive but nutritious food times 3
• assume food is 1/3 of budget
Trends in Poverty
 Incidence of Poverty

 elderly
 children/families
headed by single women
 rural
Llad Phillips
42
Llad Phillips
43
Incidence of Poverty Among the Aged and the Young
Children: 14.9% in 1970 to 21.2% in 1994
Llad Phillips
Source: Economic Report of the President, 1997
44
Llad Phillips
45
Percentage of Births Occuring Out of Wedlock, .
White Women by Age Group, US
.
35
15-19
20-24
25-29
30
Percent
25
20
15
10
5
0
1955
1960
1965
1970
1975
1980
Year
Llad Phillips
46
Percentage of Births Occurring Out of Wedlock, .
Black Mothers By Age Group, US
90
15-19
20-24
25-29
80
70
Percent
60
50
40
30
20
10
0
1955
1960
1965
1970
1975
1980
Year
Llad Phillips
47
US Families Headed By Women in Percent
.
45
40
35
White
Black
Percent
30
25
20
15
10
5
0
1940
1950
1960
1970
1983
Year
Llad Phillips
48
Marriage and Divorce Rates Per 1000 Population, US
.
12
10
Marriages
Divorces
6
4
2
1992
1989
1986
1983
1980
1977
1974
1971
1968
1965
1962
1959
1956
1953
0
1950
Rate
8
Year
Llad Phillips
49
US Marrige Rates Per 1000 Population, .
Unmarried Women 15-44 Years Old
160
140
120
80
60
40
20
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
0
1970
Rate
100
Year
Llad Phillips
50
Summary-Vocabulary-Concepts








input factor shares
distribution of
personal income
distribution of family
income
frequency distribution
of income
cumulative
distribution of income
Lorenz curve
Gini coefficient
median family income
Llad Phillips








part-time, part-year
worker
full-time, full-year
worker
within group variation
in earnings
ability differential
between group
variation in earnings
education differential
experience differential
definition of poverty
51