1. Llad Phillips1 Introduction to Economics Elements of Personal Finance

2. Llad Phillips2 Outline: Lecture Three Housing Loans: Interest and Equity Housing Loans: Interest and Equity Determinants of Personal Income Determinants of Personal Income

3. Llad Phillips3 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. Llad Phillips4 Problems O & S Text p. 56: 1, 2, 3 p. 149: 1, 2, 3

5. Llad Phillips5 Strategies for Meeting Future Expenses Buy a House Buy a House  most valuable asset for most US households  commitment to monthly payment Tax-Sheltered Savings Plans Tax-Sheltered Savings Plans  commitment to monthly payment Stocks and Bonds Stocks and Bonds

6. Llad Phillips6 Buying a House Positives Positives  provides space  builds equity  interest is deductible Negatives? Negatives?  down payment requires saving for this goal  interest payments are front-loaded, equity growth delayed  opportunity cost of not investing in stocks

7. Llad Phillips7 Source: UCSB Economic Forecast Project Is Housing a Good Investment for the Nineties?

8. Llad Phillips8 Example for an $80,000 House price: $80,000 price: $80,000 down payment: $20,000 down payment: $20,000 loan: $60,000 loan: $60,000 interest rate: 10% interest rate: 10% loan term: 25 years loan term: 25 years

9. Llad Phillips9 calculated using TKSOLVER Level Debt Service Module

10. Llad Phillips10 Slow Growth In Equity Interest is front loaded Interest is front loaded Start with $20,000 equity in example Start with $20,000 equity in example After 10 years, gained about $10,000 equity After 10 years, gained about $10,000 equity After 20 years, gained about $35,000 equity After 20 years, gained about $35,000 equity Last 5 years, gain last $25,000 in 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

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14. Llad Phillips14 Interest Cost You may not care so much You may not care so much  if you are experiencing capital gains  i.e. the value of the house is rising

15. Llad Phillips15 Source: UCSB Economic Forecast Project Is Housing a Good Investment for the Nineties?

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17. Llad Phillips17 Demand for Housing Loans You are more likely to buy a house if the mortgage rate is low 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 mortgage credit if the mortgage rate is low More people will be buying houses and demanding mortgages if their income is rising 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

18. Llad Phillips18 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % 7 %

19. Llad Phillips19 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % Higher Personal Income

20. Llad Phillips20 Quantity of Mortgage Credit  Mortgage Rate, Personal Income Expressing The Demand For Mortgage Credit 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 1. Words 2. Symbols 3. Pictures r Q

21. Llad Phillips21 Price, Mortgage Rate Quantity of Mortgage Credit Demand for Mortgage Credit 10 % 7 %

22. Llad Phillips22 The importance of saving commitment commitment  discipline personal income personal income  determinants managing expenses managing expenses  income-expense statement  budgeting

23. Llad Phillips23 Determinants of Personal Income The Life Cycle Model

24. Llad Phillips24 An Individual’s Life Cycle for a Socially Productive Life Learning over the life cycle Learning over the life cycle Accumulating earning power or human capital Accumulating earning power or human capital Earnings depend upon Earnings depend upon  ability  knowledge  work experience

25. Llad Phillips25 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

26. Llad Phillips26 Accumulating Human Capital InflowOutflow Stock

27. Llad Phillips27 Accumulating Human Capital Stock Inflow + - Outflow Net Inflow

28. Llad Phillips28 Accumulating Human Capital Human Capital Learning + - Depreciation Investment Human Capital: An Asset Like a Car or a House: It Depreciates

29. Llad Phillips29 Allocation of Your Time Human Capital Build Capital by Learning Use Capital for Earning

30. Llad Phillips30 Time Endowment 24 hours

31. Llad Phillips31 24 hours0 hours Leisure (learning)

32. Llad Phillips32 Allocation of Your Time Human Capital Build Capital by Learning Use Capital for Earning

33. Llad Phillips33 24 hours0 hours Leisure (learning) Earnings $480 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) $ 0

34. Llad Phillips34 Salaries by Education Level, CA Full Time* Workers *Full Time: >35 hrs/wk, >48 wks/yr.; Source: LA Times, 1-10-93

35. Llad Phillips35 The Rich Get Richer and the Poor Get Poorer Why does poverty persist in an affluent country like the US? Why does poverty persist in an affluent country like the US?

36. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 $240 dropout college grad Comparative market wages as determined by accumulated knowledge

37. Llad Phillips37 Choosing Between Learning and Earning How much time for learning? How much time for learning? How much time for earning? How much time for earning? This choice, like all choices depends on your tastes 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?

38. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally(step two of the paradigm: valuing the alternatives for choice) Depicting your tastes graphically: iso-preference or indifference curves

39. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value Depicting your tastes graphically

40. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 Iso-Preference Curves: You value all points on a curve equally high low value high value The choice between leisure and earning now:picking the best alternative alternatives

41. 24 hours0 hours Leisure (learning) Earnings $480 $ 0 high low value high value Optimum 15 hours of leisure $180 for 9 hrs of work Individual’s Supply of Labor

42. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work

43. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work $96 dropout is unwilling to work for $4/hr

44. Llad Phillips44 Why does the youth drop out? may not like school may not like school may receive bad or no advice may receive bad or no advice  parents  counselors

45. Life Cycle Approach: The Planners Age InfancyAdolescence Young AdultAdultSenescence 100% 50% 0 % You Parents

46. Llad Phillips46 Participation in the Labor Force: Willing to look for work If your market wage exceeds your reservation wage 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 We assumed the college grad and the dropout both have the same values for income and leisure Only their learning histories differ Only their learning histories differ

47. 24 hours 0 hours Leisure (learning) Earnings $480 $ 0 high low value slope of the iso-preference curve through the 24 hour endowment is the lowest wage at which you are willing to work $96 dropout is unwilling to work for $4/hr

48. Llad Phillips48 Summary-Vocabulary-Concepts median median demand curve demand curve mortgage rate mortgage rate personal income personal income mortgage credit mortgage credit rule of correspondence rule of correspondence stock stock inflow inflow outflow outflow time endowment time endowment allocation of your time allocation of your time  learning(leisure)  earning in future  earning now iso-preference curves iso-preference curves reservation wage reservation wage