Thursday, September 27, 2007

Economists vs Voters

Bryan Caplan, an economist at George Mason, has an excellent article on how Economists view the world vs how your "average" joe views the world. You can read it here.

Although the article is about why voters and politicians choose bad economic policies, I believe that the article can also be used to teach us what makes an economy grow in the first place. The short answer is markets and the rule of law, but this explanation is a great summary of how we economists think.

There are too many variations on anti-market bias to list them all. Probably the most common error of this sort is to equate market payments with transfers, ignoring their incentive properties. (A transfer, in economic jargon, is a no-strings-attached movement of wealth from one person to another.) All that matters, then, is how much you empathize with the transfer’s recipient compared to the transfer’s provider. People tend, for example, to see profits as a gift to the rich. So unless you perversely pity the rich more than the poor, limiting profits seems like common sense.

Yet profits are not a handout but a quid pro quo: If you want to get rich, you have to do something people will pay for. Profits give incentives to reduce production costs, move resources from less-valued to more-valued industries, and dream up new products. This is the central lesson of The Wealth of Nations: The “invisible hand” quietly persuades selfish businessmen to serve the public good. For modern economists, these are truisms, yet teachers of economics keep quoting and requoting this passage. Why? Because Adam Smith’s thesis was counterintuitive to his contemporaries, and it remains counterintuitive today.

A prejudice similar to the one against profit has dogged interest, from ancient Athens to modern Islamabad. Like profit, interest is not a gift but a quid pro quo: The lender earns interest in exchange for delaying his consumption. A government that successfully stamped out interest payments would be no friend to those in need of credit, since that policy would crush lending as well.

Macroeconomics - Topic 3

Click here for Topic 3, which will give you the outline for inflation, unemployment and GDP

Macroeconomics Quiz 3 - Due Tues Oct 2nd

Quiz 3
Professor Matthew Festa
EC207 – Macroeconomics.
Due in class Tuesday Oct 2nd

1) (2 points)The Kingdom of Rohan has an economy made up of only two goods: Horses and spears. In the Third Age 1997 output and prices were

100 spears for $1.00 a spear
200 horses for $2.00 a horse.

In TA1998, the economy increased the output of both in order to prepare for war against the Dark Lord. Output and prices in 1998 were

200 spears for $2.00
300 horses for $3.00

Based on the information given above, calculate the percentage increase in GDP from 1997 and 1998 in BOTH nominal and real terms. (for real GDP, use 1998 prices)

2) (1 point) Calculate the unemployment rate based on the information given below:

The labor force participation ratio 200 million
Unemployed people = 10mn
Please provide your answer in percentage terms

3) (2 points) Please name and explain in full sentences the 3 types of unemployment and what they are.

4) (1 point) The CPI index in 2000 was 100. In 2001 the CPI index was 110. What is the percentage increase in the overall price level from 2000 to 2001?

5) High inflation is damaging to the economy from the perspective of the fixed wage earner and a lender (i.e. someone who lends money) because? (2 points)

6) Using a graph (in English, zero credit for no graph ) please explain the effects of the following on price and quantity. (2 points)

A new technology developed in which mass machines will now produce HDTV’s instead of the man made way in which these sets were made previously. At the same time Cable television announced to all customers that all stations will now have HDTV capability if the user has a compatible television. What is the effect of price and quantity of these 2 bits of information? (Hint: think carefully)

More Home Sales data

As I expected the new home sales data for Aug came in weak, falling 8.3%. New Home sale prices (median) were down 7.5%. This is arguably a better reflection of the types of price declines that will be needed in order to bring the market into balance. The idea is that home builders will not want to hang onto their inventory nearly as long as existing home owners, so they will cut their prices faster.

Better news came from the job front in the form of initial claims data. Initial claims data is a weekly measure of the amount of people who initiate a claim for unemployment insurance. The amount of people initiating such a claim fell to 298k. This suggests that the Aug labor report, which showed a 4k drop in unemployment may have been an aberration.

Now you can see the difficulty in conducting monetary policy.

Wednesday, September 26, 2007

Home Sales Data

The world of Macroeconomics moves on at a fast pace and there is some interesting data coming out about the housing market. In short, it is getting worse.

The government releases 3 main indicators of home sales: existing home sales (homes already built being sold), new home sales and pending home sales (when the buyer and seller agree and the deal is pending approval.)

Earlier this week we saw the release of existing home sales. You can read the economist James Hamilton's summary here. As you can see, Aug new home sales dropped another 3.8% from Jul. Worse is that there is a 10.7 month inventory, meaning that it will take close to a year to sell all the existing homes on the market. And if that is not bad enough, this data usually includes deals that were in place about a month ago but just closed in Aug. So they don't even include the credit crunch that happened in Aug (just a few weeks before you started). So as you can probably divine, we should expect home prices to start falling.

Luckily for us, also released this week was the Case Schiller Home Price index. Prof. Hamilton explains exactly how this index measures home prices, but as you can see prices are already falling (3.9% lower from one year ago this month). This does not seem like a lot, but when you couple this release with the article I posted last week , I think we can expect further price reductions in homes.

Due up on the plate tomorrow (Thurs) is new home sales for Aug. This is a good release because it will show more of the effect of the Aug credit crunch as well as offer a price estimate of new homes on the market. If the number is weak, look for more pressure on the federal reserve to cut rates.

What are the short run implications of this?

1) Lower home sales mean less construction of homes, this lowers GDP directly in the short run because companies are not starting home building (decline in investment in residential construction).
2) Falling home prices could (and probably will) hurt consumption indirectly because a lot of consumers probably borrowed money against their home to finance spending (mostly on kitchens, living rooms, etc.). This impact is the most debated among economists. Some argue the effect will be huge, some argue the effect will be small.
3) The inability of mortgage borrowers of ARM's to pay off their loans coupled with the markets inability to tell who is going to default and where, means that the market is punishing everyone via higher interest rate spreads. This should hurt consumption and investment.

Medium term implications?

The short run fall in growth is already inducing Fed rates cuts. I would be further rate cuts are in the making and so does the market. If the fed plays this right, they will balance the risks to growth to the risks to inflation. However, if they cut too much then they run the risk of pushing inflation up in the medium term. (Professor Greg Mankiw of Harvard has an interesting post on whether this is being anticipated by the market). If they do not cut enough then the short run effect will be more pronounced, but the market will stabilize.

Long run implications?

As we discussed on Tues, the long run implications are fairly straight forward. Over the long haul the market will adjust. Home prices will fall enough to induce more buyers into the market. Once the inventory of homes is sold, construction of new homes should pick back up and growth will resume (especially as home prices start stabilizing). Growth will return back to normal.

Monday, September 24, 2007

The housing market and macroeconomics

This is a good NY times article on the housing market. Click here .

The jist of it is this paragraph.

“The buyers and the sellers are the same people in this market,” Professor Mayer said. “So if the sellers price so high that they, effectively, put themselves out of the market, it shows up on the buying side, too.”
He notes that economists at the Federal Reserve and elsewhere keep close tabs on this kind of behavior because the purchases of durable goods like furniture, appliances and televisions tend to run hand in hand with home purchases — and durables have a disproportionate influence on the business cycle. Further, because the freezing of the housing market makes it harder for people to move, it reduces the likelihood that they can quickly relocate for higher-paying jobs. Dysfunction in the housing market can spill over into the job market, too."

The idea is that sellers do not want to accept a price loss on their home. So they price their homes too high for demanders to buy (a surplus). Since the housing market is "illiquid," it takes a long time for them to accept the fact they made a bad investment, lower the price and cut their losses.

However, this has "macro" economic implications in the sense that people buy furniture and other durable goods when they move into a new home. So sales of those products suffer (demand shifts left/down). Further, sometimes these people are so irrational that they refuse to sell their home even though it means they have to turn down a higher paying job. So the job market suffers due to a shortage of workers.

Wednesday, September 19, 2007

Macroeconomics Quiz 2 - Supply and Demand (continued)

EC208 Intro to Macroeconomics – Quiz 2

Professor Matt Festa

Due in class: Tuesday Sep 25th.

1) Draw the supply and demand graph for cement. Developing countries have been growing extremely fast for the past 5 years and the government are now required to improve the roads and infrastructure in the countries. Show any shifts in the supply and/or demand curve for the cement market and tell me the effect on price and quantity. (2 points)

2) Draw the supply and demand graph for bagels. A recent study by weight watchers has shown that one slice of pizza is about 10-12 points on the point scale. Given that the average weight watchers client can only consumer 20-25 points a day, this means that 1 slice of pizza is about half the allotted food a client can eat the entire day. Before this study, consumers assumed that the points were about half the new estimate (around 5). Show any shifts in the supply and/or demand curve for the pizza market and tell me the effect on price and quantity. (2 points)

3) Draw the supply and demand curve for the crude oil market. A recent hurricane hit the southeastern part of the United States. Unfortunately for the oil industry, most of the countries oil refineries are located right along this area. Most of them have been destroyed and now much less oil can be processed for consumption. Show any shifts in the supply and/or demand curve for the crude oil market and tell me the effect on price and quantity. (2 points)

4) Draw the supply and demand for nursing care. Over the past few years the average age of the population increased from 40 to 45 years (meaning there are now more older people in the population. Show any shifts in the supply and/or demand curve for nursing care. What will be the effect on price and quantify of this change in the population composition? (2 points).

5) Draw the supply and demand curve for Ford. Ford develops a new technology that allows for cars to be manufactured quicker and cheaper. In addition, the news reports have been praising the new Fusion car for its fuel efficiency and hot style. Show any shifts in supply and/or demand. What will be the effect on price and quantity of this new information? (2 points).

Tuesday, September 18, 2007


That quiz one is due today. Click on the link on the right hand side of this webpage for the quiz.

Fed meeting today

If you weren't aware there is an important Federal reserve meeting today, where the bank is expected to cut the fed funds rate either 25bps (5.0%) or 50bps (4.75%). "Bps" is a financial term that translates as 1% = 100bps.

You can read our current Fed chairman's views on the Great depression here. It's a bit complicated for someone with no macro, but it will be interesting to see how much you "get" now versus how much you "get" after finishing the course. (Of course, I will explain things in plain english).

Thursday, September 13, 2007

Economics graduates are exploding in #'s

Check out the link here

Here is an interesting fact:

Meanwhile, elite schools are reporting that the number of economics majors is exploding. For the 2003–2004 academic year, the number of economics degrees granted by U.S. colleges and universities increased 40 percent from five years previously. Economics is seen by bright undergraduates as the path to a high-paying job on Wall Street or at a major corporation.

Of course, as an economist it is always good to look at the data.

Random Selection

Economics - Starting 74,000 10y average 189,000
Accounting 54,000 115,000
Finance 90,000 250,000
Comp Sci 58,000 108,000

It seems that the argument is correct with respect to Economics and Computer Science. However, I would be interested in seeing the figures for Finance majors. One possible explanation is that the average in Finance is biased by a few outliers (who make a ridiculous amount of money), although one would think the same argument holds for economics majors (which compete for similar positions).

Macroeconomics Quiz 1 - Due Tues Sep 18

Intro to Microeconomics – Quiz 1 – Supply and Demand.

(10 points)

Professor Festa 18/09/2007

This Quiz is due in class by Tues Sep 18th

Please put work on a separate piece of paper.

Use graphs where necessary.

1) Please draw a supply and demand graph with price and quantity on the correct axis. Provide me with the common sense reason plus one additional economic argument as to why the demand curve slopes down with respect to price? (2 points)

2) Why do we normally assume that the supply curve slopes upwards? (1 point)

3) Where will the equilibrium price be on the graph? Explain and show why that is the equilibrium point and not another point on the graph. (2 points).

4) Name 2 characteristics that will shift the demand curve. Then give an example for each and explain which way the demand curve will shift (draw the graph). (2.5 points).

5) Name 2 characteristics that will shift the supply curve. Then give an example for each and explain which way the supply curve will shift (draw the graph). (2.5 points).

Friday, September 07, 2007

Bad employment report

As we get into macroeconomics we will be discussing employment and unemployment. Today saw the release of the Aug Non Farm payroll report ( basically non farm sector job growth). The report was unexpectedly bad and you can read about it here.

The Federal Reserve is widely expected to lower the fed funds rate -- the rate at which banks lend to each other -- for the first time in over four years when it meets on Sept. 18, by 25 basis points to 5%. It has already lowered the discount rate it charges banks that borrow directly from the Fed by 50 basis points.

The key question I want you to ask yourself is why a weak employment report would cause the Federal reserve to "cut" the fed funds rate (currently at 5.25%, expected to be cut to 5.0 or 4.75% on Sep 18th).

Answer (you may not understand this until we cover the relevant section).

The federal reserve has a dual mandate, full employment and price stability. Up until recently the Fed was primarily worried about inflation or price stability. Therefore they had what is called a hawkish bias. That is, they were more inclined to raise rather than lower rates. Higher rates increase borrowing costs and slow the economy and the price level down.

Now with the housing market in a full blown recession, there is worry that this particular market will cause a full blown economy wide recession. The latest employment report signalled that this probability has increased since firms have stopped hiring workers, at least for this month. Therefore, the markets are now expecting the Fed to cut the rate in order to lower borrowing costs and provide an incentive for firms to hire workers and boost the growth rate.

Thursday, September 06, 2007

Macroeconomics - fall 2007 outline

Part I - Introduction to Economics

Chapter 1 - The Nature of Economics
Chapter 2 - Scarcity and the world of trade offs
Chapter 3 - Demand and Supply (will work in some concepts from Chapter 4)

Part II - Macroeconomic Basics

A) Basic Macroeconomic variables
Chapter 7 - unemployment, inflation and deflation
Chapter 8 - GDP (probable test 1)

B) Macro Economic Theories
Chapter 10 (and parts from 9) - Economic growth in the long run
Chapter 10-11 - Classical vs Keynesian economics, the multiplier
Chapter 15 - Money and Banking
Chapter 17 - Monetary policy (probable test 2)

C) The global economy
Chapter 33 - Comparative advantage and free trade
Optional - Chapter 34 - Exchange rates and the Balance of Payments

Wednesday, September 05, 2007

Fall 2007 Syllabus - Macroeconomics

Nassau Community College
Department of Economics and Finance

Course Outline: Economics 207: Principles of Macroeconomics, 2007– 2008

Required Text: “Economics Today – The Macro View” 14th Edition.
Roger LeRoy Miller; Pearson Education 2008.

Optional Texts: Other articles that I will incorporate into the class will either be provided by me or available free online.

Instructor: Matthew Festa, MA E-mail:
Telephone: (cell) 516-987-0299 Dept: 516-572-7181
Office: None Office Hours: by request

Part I: What is this course about?

Catalog Description: This is an introductory course which views behavior of the economy as a whole and the problems of economic organization. Students will explore the fluctuations of output and prices. Problems and measurement of economic growth, inflation and unemployment as income will be discussed. Money, credit and financial institutions will be analyzed, as well as their impact on fiscal policies and international trade

Online resource: This semester I will try and incorporate the internet into the class. I found last semester that lots of quizzes, articles and even this very syllabus went missing for mysterious reasons that defy explanation. Therefore, I will try and get around that problem by posting most take home quizzes, class outlines, article, the syllabus and the course outline online on my blog. You can access this material here: On the right hand side are the links to all important documents so you do not have to search for them.

II Grades

30% exams (2 tests)
30% Final
30% Quizzes
10% class Participation

I will be giving 2 tests, the dates of which I will determine as the course progresses. Individually each midterm will be worth 15% of your grade. A final, given at the end of the term, will be 30% of your grade. I will be giving a take-home quiz/homework assignment once a week that you can take from the comfort of your home. Each quiz is 10 points. To get your quiz score you simply divide your points by the total possible quiz points. However, since quizzes can be annoying, I will do the following. I will allow each student the option of substituting his or her quiz average for their lowest midterm grade (note: this option is not available for the final exam). As you will soon learn, incentives matter, and this should provide you with enough of an incentive to take these quizzes seriously. It also gives you a bit of a leeway if a bad day occurs on one of the midterms. No Makeup exams will be given unless there is an extraordinary circumstance. If you believe you qualify please contact me immediately.

So what about class Participation? I am basing your class participation grade mainly on your attendance and your participation in class (i.e. questions are good, sleeping is not). I will allow up to 3 absences without penalizing your class participation grade. This should allow you room in the event that you cannot make any one class for whatever reason may arise.

Extra Credit: As a student I always loved extra credit opportunities and I believe they are a good learning tool. So here is how I will help you. If there is any article that you come across that is relevant to the class (either on your own or on the website) I want a 1-2 page analysis of what the article is saying and how it applies to what I have taught you. You can do up to 3 with each one worth 2 points (maximum 6 points).

Math Background: Economics is an empirical science and thus knowledge of mathematics is essential to success in the discipline. However, being that this is a principles class, I am going to restrict the math to the basics: so knowledge of arithmetic is required for this class. Calculators are permitted (as they will be when you get a job). You do not need to know advanced math, but I will ask you to do some arithmetic work on the quizzes and tests.

Withdrawal Policy – Department Policy for withdrawals is as follows: Students can withdraw from a course at any time up to and including the official withdrawal date of November 5th. After that date, students will only be given withdrawal for extraordinary reasons supported by appropriate documentation. This documentation will be copied and retained by me.

The “W” grade is only guaranteed to those students who officially withdraw from class and obtain the faculty member’s signature during the automatic withdrawal period. Most important, a grade of “W” cannot be granted to any student who takes the final examination.

Note: The “W” grade may possibly impact financial aid and Academic Standing