Economics Lecture: The Role of Goods and Services in the Circular Flow of an Economy, Study notes of Introduction to Macroeconomics

Download Economics Lecture: The Role of Goods and Services in the Circular Flow of an Economy and more Study notes Introduction to Macroeconomics in PDF only on Docsity! ECO 155 750 LECTURE SIXTEEN 1 OKAY. WHAT WE WANT TO DO IS TALK ABOUT GROSS DOMESTIC PRODUCT SOME MORE TODAY -- QUITE A BIT, ACTUALLY. WHAT WE WANT TO DO IS BUILD A LITTLE BIT OF A MODEL OF THE ECONOMY, KIND OF A SIMPLE MODEL OF THE ECONOMY. AND WE'LL START OFF WITH JUST TWO SECTORS IN OUR ECONOMY, THE HOUSEHOLD SECTOR AND THE BUSINESS SECTOR. LET ME PUT LITTLE BOXES HERE AND I'LL JUST LABEL THOSE "HOUSEHOLD SECTOR" AND "BUSINESS SECTOR." NOW, THE HOUSEHOLD SECTOR AND THE BUSINESS SECTOR ARE TIED TOGETHER IN OUR ECONOMY IN TWO DIFFERENT WAYS. HERE'S ONE WAY. THE HOUSEHOLD SECTOR SUPPLIES FACTORS OF PRODUCTION OR RESOURCES. LET ME JUST KIND OF DRAW THIS DEAL GOING THIS WAY, WHERE WE SAY RESOURCES OR FACTORS OF PRODUCTION -- I'LL USE BOTH TERMS SOMETIMES -- THAT IS THE LAND, LABOR, CAPITAL AND ENTREPRENEURSHIP THAT BUSINESSES REQUIRE, THE RESOURCES THEY REQUIRE, TO PRODUCE GOODS AND SERVICES. OKAY. AND SO THERE'S ONE LINK BETWEEN THE HOUSEHOLD SECTOR AND THE BUSINESS SECTOR. THE HOUSEHOLD SECTOR SENDS THOSE FACTORS OF PRODUCTION OR THOSE PRODUCTIVE RESOURCES TO THE BUSINESS SECTOR. GUESS WHAT HAPPENS? THE BUSINESS SECTOR SENDS MONEY BACK. AND I'LL SWITCH OVER TO A DIFFERENT COLOR HERE TO SHOW YOU THE FLOW OF MONEY COMING BACK. HERE'S THE DOLLARS COMING BACK AND THESE ARE, WHAT, RESOURCE PAYMENTS. AND, BY THE WAY, WHAT YOU ECO 155 750 LECTURE SIXTEEN 2 CAN KIND OF THINK ABOUT HERE IS, THAT IT'S NOT JUST LIKE THE HOUSEHOLD SECTOR SENDING RESOURCES OFF AND THE BUSINESS SECTOR SENDING DOLLARS OFF. THERE'S REALLY SUPPLY AND DEMAND TAKING PLACE IN THE RESOURCE MARKET, AND IT'S SUPPLY AND DEMAND THAT DETERMINES THE PRICE OF THOSE RESOURCES AND THE QUANTITY THAT'S HIRED. OKAY. BUT ANYWAY, SO IT'S SUPPLY AND DEMAND IN THIS MARKET THAT DETERMINES HOW MANY RESOURCES GET SENT, HOW MUCH REVENUE OR HOW MANY DOLLARS COME BACK TO THE FACTOR OF PRODUCTION OF THE HOUSEHOLD SECTOR. OKAY. NOW, THAT'S ONE LINK BETWEEN THE HOUSEHOLD SECTOR AND THE BUSINESS SECTOR. THE OTHER LINK IS THIS: THE HOUSEHOLD SECTOR NEEDS GOODS AND SERVICES. YOU KNOW, THESE PEOPLE HAVE GONE TO WORK, THEY'VE GOTTEN PAID, BUT NOW THEY NEED THINGS LIKE A CAR, A HOUSE, GROCERIES, AND SO FORTH. AND SO THE OTHER PART OF THE STORY IS, THE HOUSEHOLD SECTOR SENDS AWAY DOLLARS, THE DOLLARS THEY RECEIVED JUST A MOMENT AGO. THEY SEND AWAY DOLLARS -- AND THESE DOLLARS ARE CALLED EXPENDITURES -- AND RECEIVE IN RETURN GOODS AND SERVICES. AND THE HOUSEHOLD SECTOR MEETS THE BUSINESS SECTOR IN THIS MARKET FOR GOODS AND SERVICES, AND I'LL AGAIN DRAW SUPPLY AND DEMAND, AND THERE'S WHERE PRICES GET DETERMINED AND QUANTITIES, AND SO FORTH. AND THIS IS A GOODS MARKET OR GOODS AND SERVICES ECO 155 750 LECTURE SIXTEEN 5 SECTOR AND HEAD ON THEIR WAY TO THE MARKET. OR WE COULD MEASURE THE VALUE OF ECONOMIC ACTIVITY BY STANDING OVER HERE AND WATCHING THE DOLLARS COME OUT OF THE HOUSEHOLD SECTOR AND BEING SPENT. OR WE COULD STAND OVER HERE AND WATCH THE BUSINESSES SEND DOLLARS OUT TO THE FACTORS OF PRODUCTION. WE COULD MEASURE THOSE DOLLARS AND WE WOULD HAVE A MEASURE OF MACROECONOMIC ACTIVITY. THERE'S SEVERAL DIFFERENT MEASURES OF ECONOMIC ACTIVITY THAT WE CAN RELY ON, OR THAT WE CAN OBSERVE AND THINK ABOUT AND TALK ABOUT AND SO FORTH. OKAY. SO THAT'S ONE POINT WE WANT TO MAKE. HERE'S A SECOND POINT. WE WANT TO UNDERSTAND THE IDEA OF LEAKAGES AND INJECTIONS INTO THE CIRCULAR FLOW. THAT'S ONE WORD, INTO. IT'S NOTHING TO SNEEZE AT. LET'S THINK ABOUT A LEAKAGE HERE. SUPPOSE SOMETHING LIKE THIS HAPPENS. LET ME SEE WHERE I'LL PUT THIS IN. SUPPOSE SOMETHING LIKE THIS HAPPENS. THE HOUSEHOLD SECTOR, THEY'VE GOT THEIR RESOURCE PAYMENTS COMING IN. THIS IS THEIR INCOME, RIGHT? THIS SAME THING IS HOUSEHOLD INCOME COMING FROM THE -- YOU KNOW, THE RESOURCE PAYMENT IS FROM BUSINESSES UP HERE TO THE HOUSEHOLD WHO SAYS, "HEY, THERE'S SOME INCOME COMING IN." THAT'S YOUR PAYCHECK AND THAT'S THE INTEREST YOU RECEIVE FROM THE BANK, OR THAT'S THE DIVIDENDS YOU GET FROM THE CORPORATION, OR SO FORTH. BUT ANYWAY, SO HERE COMES THIS INCOME. AND WHAT WE'VE ECO 155 750 LECTURE SIXTEEN 6 ASSUMED RIGHT HERE IS THAT THOSE DOLLARS JUST GO THROUGH THE HOUSEHOLD AND GET SPENT. SUPPOSE SOMETHING LIKE THIS HAPPENS, THOUGH. SUPPOSE HOUSEHOLD INCOME, WE'LL SAY, IS A HUNDRED DOLLARS AND SUPPOSE THAT EXPENDITURES ARE EQUAL TO EIGHTY DOLLARS, AND THAT THE HOUSEHOLD TAKES TWENTY DOLLARS OVER HERE AND PUTS THAT INTO SAVINGS. SAVINGS. SO THE NEXT TIME AROUND -- I MEAN, THERE WERE A HUNDRED DOLLARS THAT LEFT THE BUSINESSES. THEY SENT A HUNDRED DOLLARS TO THE HOUSEHOLD SECTOR AND THE HOUSEHOLD SECTOR A MINUTE AGO WOULD SPEND THAT HUNDRED DOLLARS, AND HERE YOU COME BACK TO BUSINESSES. BUT NOW WE HAVE SOMETHING THAT WE'RE GONNA CALL A LEAKAGE - - HERE'S A LEAKAGE -- FROM THE CIRCULAR FLOW. AND WHAT HAPPENS IS, SOME OF THOSE DOLLARS MIGHT LEAVE THE CIRCULAR FLOW AND NOT COME BACK TO BUSINESSES. AND SO THE NEXT TIME AROUND, BUSINESSES JUST HAVE EIGHTY DOLLARS COMING IN. AND IF BUSINESSES JUST HAVE EIGHTY DOLLARS COMING IN, THEY'RE SAYING, "WOW, WE'RE NOT SELLING VERY MUCH, YOU KNOW? WE WERE SELLING A HUNDRED DOLLARS WORTH OF GOODS AND SERVICES AND NOW WE'RE ONLY SELLING EIGHTY DOLLARS WORTH OF GOODS AND SERVICES." AND THEN WHAT THEY'LL SAY IS, "YOU KNOW, WE BETTER CUT BACK ON OUR PRODUCTION." RIGHT? AND WHEN THEY SAY "WE BETTER CUT BACK ON PRODUCTION," THEN WHAT THEY SAY IS, "WE DON'T NEED SO MANY FACTORS OF PRODUCTION OR RESOURCES ANYMORE AND SO WE DON'T NEED TO HIRE A HUNDRED DOLLARS WORTH OF ECO 155 750 LECTURE SIXTEEN 7 WORKERS ANYMORE -- WORKERS AND CAPITAL AND SO FORTH. WE JUST DON'T NEED A HUNDRED DOLLARS." AND SO THE POINT IS, THIS NUMBER WOULD START GOING DOWN. MAYBE IT WOULD GO DOWN TO EIGHTY. AND I DON'T REALLY WANT TO GO AND TRACE THROUGH ALL THE PARTICULAR EFFECTS OF WHAT THIS MIGHT DO. BUT THE POINT IS, AS SOON AS WE HAD THIS LEAKAGE COMING OUT OF THE CIRCULAR FLOW AND THOSE DOLLARS DON'T JUST KEEP SPINNING ROUND AND ROUND HERE, AS SOON AS THAT HAPPENS, THEN WE START RUNNING INTO PROBLEMS OF THE BUSINESS SECTOR MAKING THESE RESOURCE PAYMENTS. AND IF THEY DO -- LET'S GO BACK TO MY POSSIBILITY HERE. LET'S SAY THIS GOES DOWN FROM A HUNDRED TO EIGHTY DOLLARS. THEN THE NEXT TIME AROUND THE HOUSEHOLD SECTOR SAYS, "WE ONLY HAVE EIGHTY DOLLARS IN INCOME." AND SO NOW WHAT'S GONNA GO AROUND -- WELL, THEY MIGHT SAY IN THE NEXT TIME PERIOD, "LET'S SAVE FIFTEEN AND LET'S SPEND ONLY" -- WHAT, EIGHTY MINUS FIFTEEN -- "SIXTY-FIVE." THIS WOULD GO DOWN AGAIN. THE POINT IS, WE'VE GOT THESE LEAKAGES THAT CAN OCCUR. AGAIN, THE SPECIFIC DOLLAR AMOUNTS ARE NOT WHAT WE'RE TRYING TO UNDERSTAND HERE. ONLY TO SEE THAT IF SOMEBODY CHANGES THEIR BEHAVIOR, WE'VE GOT OUR CIRCULAR FLOW, AND WHAT WE SEE -- I WANT TO GET MY FINGERS HERE INTERTWINED BECAUSE THIS IS REALLY -- I MEAN, THESE TWO SECTORS ARE DEALING WITH EACH OTHER IN TWO DIFFERENT ECO 155 750 LECTURE SIXTEEN 10 GONE. IT'S IN THE BACKYARD. SOMEDAY IT MAY BE SPENT AGAIN, BUT NOT TODAY. SO ANYWAY. BUT WHAT IF WE HAVE CREDIT MARKETS? IF YOU HAVE CREDIT MARKETS -- AND I MEAN BY THAT LIKE BANKS AND MUTUAL FUND COMPANIES, AND SO FORTH. IF WE HAVE CREDIT MARKETS, THEN SOMETHING LIKE THIS HAPPENS. THERE'S A SUPPLY AND DEMAND FOR CREDIT. THIS SAVING BECOMES A SUPPLY OF CREDIT. YOU PUT THE MONEY IN YOUR BANK. YOU'VE GOT THIS SAVING; YOU'VE EARNED A HUNDRED DOLLARS. YOU PUT TWENTY DOLLARS IN THE BANK, IN YOUR SAVINGS ACCOUNT, AND THE BANKER THEN SAYS, "HEY, I'M GONNA MAKE A LOAN, YOU KNOW? "THAT CUSTOMER GAVE ME TWENTY DOLLARS. I'M GONNA LEND THAT OUT." AND SO WHEN THE BANKER STARTS LENDING IT OUT, IT DETERMINES A CERTAIN INTEREST RATE. AND THERE'S NOT JUST A SUPPLY OF CREDIT; THERE'S ALSO A DEMAND FOR CREDIT. THERE'S ALSO BORROWING THAT TAKES PLACE. AND SO THAT TWENTY DOLLARS THAT WAS SAVED AND WAS A LEAKAGE FROM THE CIRCULAR FLOW, AND LEFT THE ECONOMY AND SORT OF DEFLATED IT, NOW THAT TWENTY DOLLARS GETS BORROWED. IT'S AS THOUGH SOMEBODY GOES OUT IN THE BACKYARD AND DIGS UP THAT CAN AND SAYS, "I HAVE YOUR TWENTY DOLLARS." AND THEN THEY -- WHICH IS ABOUT WHAT WOULD HAPPEN TO ME IF I PUT THAT MONEY IN A CAN IN MY BACKYARD. AND SO WHAT HAPPENS IS, WHOEVER BORROWS THAT MONEY -- IT COULD BE OTHER PEOPLE IN THE HOUSEHOLD, BUT IT COULD BE ECO 155 750 LECTURE SIXTEEN 11 BUSINESSES. LET'S PRETEND THAT IT'S BUSINESSES. BUSINESSES WOULD TAKE THAT MONEY -- THEY WOULD BORROW IT -- THIS IS GONNA BE A LONG WAYS AROUND HERE. BUT THE DOLLARS THEMSELVES WOULD COME TO BUSINESSES -- HERE'S CREDIT. WHY WOULD BUSINESSES BORROW? MAYBE THEY WANT TO BUILD A NEW FACTORY, A TWENTY DOLLAR FACTORY. THEY WANT TO BUILD A NEW FACTORY AND SO BUSINESSES BORROW. AND HERE'S THAT CREDIT GOING TO THEM. AND THEN WHAT THEY DO IS, THE BUSINESSES THAT BORROW THAT TWENTY DOLLARS, THEY SPEND THE TWENTY DOLLARS. PURCHASE CAPITAL GOODS. THAT IS TO SAY, WHOEVER DID THIS BORROWING -- BORROW TWENTY DOLLARS -- WHOEVER DID THE BORROWING, THEY'VE GOT THAT TWENTY DOLLARS AND NOW THEY SPEND IT AND PURCHASE SOME CAPITAL EQUIPMENT FROM ANOTHER COMPANY. FOR EXAMPLE, GENERAL MOTORS BORROWS THE TWENTY DOLLARS AND USES THAT, LET'S SAY, TO PUT SOME NEW DEVICE IN THEIR CARS, SOMETHING THAT MONITORS THE EMISSIONS AND SO FORTH AND CORRECTS POLLUTION AND DOES THOSE THINGS. WELL, WHO ARE THEY GONNA SPEND THAT MONEY WITH? MAYBE SOME OTHER COMPANY THAT MAKES SEMI- CONDUCTORS OR MAKES CERTAIN PARTS THAT GO IN CAR ENGINES THAT MAKES THEM POLLUTE LESS. SO ANYWAY, WHAT I'M SAYING TO YOU IS, IS THAT THIS TWENTY DOLLARS THAT LEFT THE ECONOMY A MOMENT AGO AS A LEAKAGE HAS NOW BECOME AN INJECTION. THESE DOLLARS ARE BEING INJECTED BACK INTO THE CIRCULAR FLOW. NOW THAT THE BUSINESSES ARE -- SOME BUSINESS IS ECO 155 750 LECTURE SIXTEEN 12 SPENDING TWENTY DOLLARS TO PURCHASE CAPITAL GOODS, NOW THERE'S EIGHTY DOLLARS COMING INTO BUSINESSES FROM SELLING TO THE HOUSEHOLD SECTOR AND THERE'S TWENTY DOLLARS COMING INTO BUSINESSES SELLING TO OTHER BUSINESSES. IT COULD'VE WORKED OUT DIFFERENTLY. MAYBE THE TWENTY DOLLARS WAS BORROWED INSTEAD BY THE HOUSEHOLD SECTOR -- LET ME JUST KIND OF TAKE THIS OUT FOR NOW. MAYBE INSTEAD WHAT HAPPENED WAS OTHER PEOPLE IN THE HOUSEHOLD BORROWED THAT TWENTY DOLLARS. SO HERE GOES THE CREDIT OF THE TWENTY DOLLARS THAT'S BORROWED IN THE CREDIT MARKETS -- DOWN AT THE BANK, FOR EXAMPLE -- AND SO NOW THERE'S TWENTY DOLLARS COMING IN THAT THE HOUSEHOLD SECTOR BORROWED AND NOW THEY WILL SPEND TWENTY DOLLARS. AND THERE'S EIGHTY PLUS TWENTY. NOW THEY'RE SPENDING A HUNDRED DOLLARS. THEY'RE SPENDING THE BORROWED MONEY PLUS THE EIGHTY DOLLARS THEY WERE SPENDING BEFORE. LEAKAGES AND INJECTIONS. SO WHAT I'M SAYING TO YOU IS THIS: THESE LEAKAGES CAUSE THE ECONOMY TO SLOW DOWN AND THESE INJECTIONS CAUSE THE ECONOMY TO SPEED UP. SPEED THE ECONOMY. WHAT'S THE SIGNIFICANCE OF THIS? THIS IS REALLY THE WHOLE STORY THAT WE'RE GONNA BE TALKING ABOUT FOR THE REST OF THE SEMESTER. THE REST OF THE SEMESTER, WHAT WE'RE GONNA HAVE IS MODELS OF THE ECONOMY AND HOW CERTAIN ACTIONS BY THE FEDERAL RESERVE OR THE GOVERNMENT, MEANING THE CONGRESS AND THE ECO 155 750 LECTURE SIXTEEN 15 VERY FRONT THAT SAYS -- AND, BY THE WAY, THIS COMES OUT EVERY MONTH AND IT'S OVER IN THE GOVERNMENT DOCUMENTS SECTION OF THE LIBRARY. BUT EVERY MONTH, BUSINESS SITUATION, THERE'S A SHORT ARTICLE AND HERE'S TABLE 1, GROSS DOMESTIC PRODUCT. SO ANYWAY, LET'S LOOK AT THIS. GROSS DOMESTIC PRODUCT IS ABOUT EIGHT TRILLION DOLLARS. SO WHAT WE WANT TO DO IS, WE WANT TO START TALKING ABOUT THIS EIGHT TRILLION DOLLARS. WHAT WOULD MAKE THAT EIGHT TRILLION DOLLARS GO UP TO EIGHT AND A HALF TRILLION? OR WHAT WOULD MAKE THAT EIGHT TRILLION DOLLARS GO DOWN TO SEVEN AND A HALF TRILLION? AND SO THE POINT -- AND I'VE ALREADY MADE THAT POINT, BUT LET ME JUST REITERATE. THE POINT IS THAT WE DON'T WANT TO JUST BE DRAWING THESE ARROWS AND GOING, "YOU KNOW WHAT I MEAN." WE WANT TO HAVE SOMETHING MORE SPECIFIC, MORE ACCURATE, IN TERMS OF HOW MANY DOLLARS ARE WE TALKING ABOUT. WHAT'S THE SIZE OF THESE IMPACTS THAT WE'RE SAYING IF THERE ARE LEAKAGES OR IF THERE ARE INJECTIONS? BY THE WAY, LATER ON WHEN WE START DRAWING SOME OF THESE OTHER DIAGRAMS AND LOOKING AT THE OTHER MODELS -- YOU DON'T NEED TO DRAW THIS BECAUSE WE'LL COME BACK TO IT LATER. WE'LL HAVE ALL SORTS OF, LIKE, COMPLICATED DIAGRAMS AND THINGS LIKE THAT ON THE BOARD. AND THOSE ARE ACTUALLY DIFFERENT DIAGRAMS, IF YOU CAN BELIEVE THAT. THEY LOOK PRETTY SIMILAR, DON'T THEY? ANYWAY, WE'LL START DRAWING SEVERAL DIAGRAMS ON THE BOARD ECO 155 750 LECTURE SIXTEEN 16 AS THE SEMESTER GOES ALONG. THERE'S ANOTHER ONE. THOSE ARE THE THREE -- AND I HAVEN'T EVEN LABELED 'EM OR ANYTHING LIKE THAT. BUT WE WILL COME BACK AND DRAW DIFFERENT DIAGRAMS TO UNDERSTAND DIFFERENT KINDS OF LEAKAGES AND DIFFERENT KINDS OF INJECTIONS. AND THEN WHAT WE WILL DO IS WE'LL BE ABLE TO SHOW, "OH, THE IMPACT ON GROSS DOMESTIC PRODUCT IS THIS MUCH" -- ONE TRILLION DOLLARS OR ONE BILLION DOLLARS, OR WHATEVER. AND WE'LL SHOW WHAT SECTORS OF THE ECONOMY ARE AFFECTED BY THESE VARIOUS LEAKAGES OR INJECTIONS, AND SO FORTH. SO ANYWAY, THIS IS MORE OR LESS WHERE WE'RE GOING WITH ALL THIS STUFF FOR THE REST OF THE SEMESTER. IF WE WANT TO -- AND THE FIRST POINT I MADE HERE AWHILE AGO WAS THAT THERE WERE SEVERAL MEASURES OF MACROECONOMIC ACTIVITY. GROSS DOMESTIC PRODUCT IS THE ONE THAT WE WANT TO TALK ABOUT TODAY. I'VE ALREADY TALKED ABOUT GROSS DOMESTIC PRODUCT QUITE A BIT. WE TALKED ABOUT A DEFINITION OF IT, TOTAL MARKET VALUE OF ALL FINAL GOODS AND SERVICES PRODUCED IN THE ECONOMY DURING A SINGLE YEAR. HEY, THAT WAS PRETTY GOOD, HUH? TOTAL MARKET VALUE OF ALL FINAL GOODS AND SERVICES USED IN THE ECONOMY DURING A SINGLE YEAR. HOW DO WE MEASURE THAT? TWO DIFFERENT WAYS. ONE, THERE'S SOMETHING CALLED THE EXPENDITURE APPROACH. WE HAD -- I HAD THIS THING UP HERE AWHILE AGO THAT WAS TALKING ABOUT ALL THE SPENDING FOR GOODS AND SERVICES EQUAL TO THE VALUE OF ALL PRODUCTION ECO 155 750 LECTURE SIXTEEN 17 EQUALS ALL RESOURCE PAYMENTS, AND SO FORTH. SO WE CAN MEASURE GROSS DOMESTIC PRODUCT BY MEASURING SPENDING. THESE THINGS, TOTAL SPENDING. THIS IS ALL THE DOLLARS THAT PEOPLE SPEND TO BUY GOODS AND SERVICES. WELL, THIS IS THE VALUE OF ALL GOODS AND SERVICES. HERE'S GDP, VALUE OF ALL GOODS AND SERVICES. AND ALL WE'RE SAYING WITH THIS EXPENDITURE APPROACH IS, I CAN MEASURE GDP BY MEASURING THE TOTAL DOLLAR VALUE OF SPENDING. AND THIS HAS GOTTA BE OBVIOUS, DOESN'T IT? THE VALUE OF EVERYTHING PRODUCED IS EQUAL TO -- AND THEN YOU SELL IT, OF COURSE -- THAT'S EQUAL TO WHAT PEOPLE PAY TO BUY IT. SO WHAT ARE THE EXPENDITURES THAT WE MEASURE FOR CONSUMPTION BY HOUSEHOLDS? WE WILL TALK ABOUT EACH ONE OF THESE IN GREATER DETAIL HERE IN JUST A SECOND. INVESTMENT SPENDING BY BUSINESSES. NOW, AWHILE AGO WHEN I DREW MY CIRCULAR FLOW DIAGRAM, WE JUST HAD THOSE TWO SECTORS -- THE HOUSEHOLD SECTOR AND THE BUSINESS SECTOR. BUT WE WANT TO RECOGNIZE A COUPLE OF OTHER SECTORS HERE. YOU KNOW, THE CIRCULAR FLOW MODEL, ITS SHORTCOMING IS IT'S TOO SIMPLE. IT DOESN'T ANSWER OUR QUESTIONS. AND SO WE'RE GONNA HAVE TO ADD TO IT. ITS STRENGTH IS THAT IT'S SO SIMPLE THAT WE CAN KIND OF GET A GOOD PICTURE OF HOW THE ECONOMY OPERATES. THE THIRD ONE IS PURCHASES BY GOVERNMENT. WE DIDN'T HAVE THE ECO 155 750 LECTURE SIXTEEN 20 YOU CAN FIX THAT DURABLE GOOD RATHER THAN REPLACING IT. AND WHAT I MEAN IS, EVERY ONCE IN AWHILE YOU JUST GO OUT AND YOU WRAP A CAR AROUND A TREE, OR SOMETHING LIKE THAT, AND YOU GOTTA THROW IT AWAY AND THAT'S THE END OF IT. BUT MORE LIKELY WHAT HAPPENS TO CARS IS THIS: MUCH MORE OFTEN A PERSON JUST SAYS, "OH, MAN. I'M SICK OF THIS CAR. I'VE BEEN DRIVING THIS THING FOR TEN YEARS." YOU KNOW HOW THAT FEELING YOU GET AS YOU'RE DRIVING DOWN THE ROAD AND JUST SICK AND TIRED OF YOUR CAR. ANYWAY, THAT'S THE FEELING I GET. "I'VE BEEN DRIVING THIS FOR TWENTY YEARS. I NEED A NEW CAR." AND THEN YOU START TO BUY A CAR. BUT IF THINGS AREN'T GOING SO GOOD, LET'S SAY WITH YOUR JOB, YOU START THINKING, "I DON'T KNOW IF I'M GONNA HAVE THIS JOB IN SIX MONTHS," OR THREE MONTHS OR WHATEVER. "I DON'T KNOW IF I CAN MAKE THOSE PAYMENTS. I'M GONNA HAVE TO START MAKING -- IF I BUY A NEW CAR, I'LL HAVE TO MAKE PAYMENTS FOR THE NEXT FORTY-EIGHT MONTHS. I'M NOT CERTAIN THAT I CAN RIGHT NOW. THINGS HAVEN'T BEEN GOING SO GREAT DOWN AT WORK. YOU KNOW WHAT I THINK I MIGHT DO? I MIGHT JUST HAVE THE CAR WORKED ON, SPEND A COUPLE HUNDRED BUCKS AND HAVE IT TUNED UP A LITTLE BIT, HAVE THIS OR THAT CHANGED, NEW TIRE PUT ON IT, AND THEN JUST GO AHEAD AND DRIVE THIS FOR ANOTHER SIX MONTHS OR A YEAR." SAME THING'S TRUE WITH A WASHER OR DRYER, YOUR REFRIGERATOR, YOUR TV. IF YOU START HAVING TROUBLE WITH DURABLE ECO 155 750 LECTURE SIXTEEN 21 GOODS, IT'S NICE TO GO OUT AND BUY A NEW ONE. BUT ON THE OTHER HAND, USUALLY WHAT YOU CAN DO IS HAVE THE OLD ONE FIXED UP OR REPAIRED, OR SOMETHING LIKE THAT. OR MAYBE NOT EVEN REPAIR IT. JUST SAY, "YEAH, I'M TIRED OF THIS CAR BUT I'M JUST GONNA KEEP ON DRIVING IT ANYWAY. IT'S JUST THAT I'M TIRED OF IT. IT'S NOT THAT IT DOESN'T WORK AND IT'S NOT THAT IT WON'T GET ME FROM POINT A TO POINT B." SO ANYWAY, HERE'S WHAT THE SIGNIFICANCE OF THAT IS. DURABLE GOODS PURCHASES TEND TO HAVE THIS CYCLE TO IT. THE CYCLE IS, PEOPLE BUY A LOT OF DURABLE GOODS WHEN THEY'RE FEELING SORT OF WEALTHY AND CONFIDENT ABOUT THE FUTURE, AND THE ECONOMY'S PERFORMING STRONGLY. PEOPLE GO OUT AND BUY A LOT OF DURABLE GOODS. AND THE SAME THING IS TRUE NOT JUST OF DURABLE GOODS, BUT ALSO HOUSES -- WHICH I SAID WE PUT INTO THIS OTHER CATEGORY. PEOPLE TEND TO BUY A LOT OF HOUSES WHEN THEY FEEL LIKE, "I CAN MAKE THOSE PAYMENTS. I'M -- YOU KNOW, I'M FEELING GOOD ABOUT MY JOB. I JUST GOT PROMOTED. MY COMPANY HAS GOT A GOOD PRODUCT. IT'S NOT ABOUT TO BE DRIVEN OUT OF THE MARKETPLACE BY A COMPETITOR. THIS IS A GOOD TIME TO BUY A HOUSE, GOOD TIME TO BUY A CAR," AND SO FORTH -- REFRIGERATOR, TV SET. SO DURABLE GOODS TEND TO GO THROUGH THESE CYCLES. WHEN YOU'RE FEELING ENTHUSIASTIC, OPTIMISTIC, BUY MORE. WHEN THINGS ARE NOT DOING SO GOOD IN THE ECONOMY, BUY LESS. WHAT'S THE ECO 155 750 LECTURE SIXTEEN 22 SIGNIFICANCE OF THAT FOR US? IT'S THIS. SINCE CONSUMER SPENDING ON DURABLES GOES THROUGH THAT CYCLE, THEN THOSE SEGMENTS OF THE ECONOMY THAT PRODUCE DURABLE GOODS, THEY GO THROUGH A CYCLE, TOO. NOW, LET ME GIVE YOU AN EXAMPLE. PROBABLY SEVERAL OF YOU ARE FROM ST. LOUIS OR KANSAS CITY. ST. LOUIS AND KANSAS CITY ARE BIG CITIES AND THEY TEND TO SPECIALIZE IN DURABLE GOODS PRODUCTION. BOTH IN KANSAS CITY AND IN ST. LOUIS THEY PRODUCE CARS. I MEAN, YOU KNOW, A LOT OF CARS. I THINK MISSOURI IS MAYBE THE THIRD BIGGEST CAR PRODUCING STATE. MIGHT BE FOURTH, BUT IT'S ONE OF THE FEW STATES THAT SPECIALIZE IN PRODUCING A LOT OF AUTOMOBILES. NOW, AUTOMOBILES ARE A DURABLE GOOD, EXPENSIVE DURABLE GOOD. SO WHAT HAPPENS IS, SINCE PEOPLE'S EXPENDITURES TEND TO GO UP AND DOWN IN THESE BIG CYCLES DEPENDING ON OPTIMISM, THEN THE DOLLARS FLOWING INTO ST. LOUIS AND KANSAS CITY TO BUY CARS -- THAT GOES UP AND DOWN, TOO. AND SO WHAT YOU'LL SEE IS, THE KANSAS CITY AND ST. LOUIS ECONOMY WILL GO THROUGH CYCLES MATCHING THOSE CYCLES OF, WHAT, OPTIMISM AND SPENDING ON DURABLE GOODS. LET'S TALK ABOUT NONDURABLE GOODS. NONDURABLE GOODS HAVE A SHORT LIFE. NOW, LET ME GIVE YOU A COUPLE OF GOOD EXAMPLES HERE OF NONDURABLE GOODS. HOW ABOUT DINNER, RIGHT, AND FOOD? SOMEBODY -- I DON'T KNOW -- THEY RAISE A COW, THEY SLAUGHTER THE COW, THEY MAKE A STEAK, THEY PUT THE STEAK ON YOUR PLATE, YOU EAT ECO 155 750 LECTURE SIXTEEN 25 SO PEOPLE DON'T DRIVE VERY MUCH THAT MONTH, YOU KNOW, IN THE SNOW. AND SINCE THEY'RE NOT DRIVING QUITE SO MUCH, THEY DON'T USE QUITE SO MUCH GASOLINE. AND SO THERE'D BE A LITTLE BIT OF A DOWN MONTH FOR PURCHASING NONDURABLE GOODS. BUT THAT'S NOT A BIG DEAL. IT WOULD JUST SHOW UP AS A SLIGHT LITTLE RIPPLE. NO BIG CYCLE. OKAY. NOW, I TOLD YOU ST. LOUIS AND KANSAS CITY -- AMONG OTHER CITIES: DETROIT, CHICAGO, AND SO FORTH. BUT BIG CITIES TEND TO BE PLACES WHERE THEY PRODUCE A LOT OF DURABLE GOODS. BUT SMALLER CITIES AND TOWNS, THEY TEND TO DO MORE NONDURABLE GOODS PRODUCTION. NOW, WHY IS THAT? WELL, THERE'S SEVERAL REASONS, BUT I'LL GIVE YOU A SIMPLE ONE. WITH DURABLE GOODS PRODUCTION, THEY'RE THESE BIG TICKET ITEMS, THEY TEND TO BE PRODUCED IN BIG FACTORIES. LIKE YOU'VE PROBABLY SEEN THE CHRYSLER PLANT UP IN ST. LOUIS OR A FORD PLANT UP IN KANSAS CITY, OR SOMETHING LIKE THAT. WHEN THEY'RE MANUFACTURING CARS, WHAT THEY HAVE IS A HUGE FACTORY AND THEY HAVE TENS OF THOUSANDS OF WORKERS SOMETIMES IN THESE BIG FACTORIES, BUT CERTAINLY THOUSANDS AND THOUSANDS, ALL IN ONE PLACE, PRODUCING CARS. WELL, YOU KNOW, IF GENERAL MOTORS WOULD MOVE TO SPRINGFIELD AND OPEN UP A FACTORY AND SAY, "OKAY. WE'RE GONNA PRODUCE CARS," AND THEY PUT OUT THE SIGN THAT SAYS "HELP WANTED," WOULD THOUSANDS OF PEOPLE SHOW UP TO GET A JOB AT GENERAL ECO 155 750 LECTURE SIXTEEN 26 MOTORS? AND THE ANSWER IS NO. THERE AREN'T THOUSANDS OF PEOPLE IN SPRINGFIELD LOOKING FOR WORK. WE SIMPLY HAVE TOO SMALL OF A LABOR FORCE. AND SPRINGFIELD IS SORT OF A MEDIUM-SIZED TOWN. WHAT ABOUT A SMALLER TOWN, YOU KNOW -- THESE THAT SORT OF SURROUND SPRINGFIELD HERE FOR A HUNDRED MILES IN ANY DIRECTION? WHAT IF GENERAL MOTORS SHOWED UP IN ONE OF THOSE TOWNS, YOU KNOW, WITH A POPULATION OF TWO THOUSAND, AND SAID, "WE WANT TO HIRE FIVE THOUSAND PEOPLE FOR OUR FACTORY." JUST COULDN'T DO IT. AND SO IF YOU'RE GONNA BE PRODUCING THESE BIG TICKET DURABLE GOODS WHICH TEND TO BE PRODUCED IN LARGE VOLUMES IN BIG FACTORIES, YOU NEED TO GO WHERE THE LABOR IS. THE LABOR IS IN BIG CITIES. IT'S THIS WAY THE WORLD OVER. NONDURABLE GOODS, THAT TENDS TO BE SOMETHING THAT WE CAN PRODUCE VERY OFTEN IN SMALLER QUANTITIES IN SMALLER LOCATIONS. AND SO ANYWAY, WE TEND TO SEE NONDURABLE GOODS PRODUCTION IN SMALLER TOWNS. HERE'S THE NEWS ABOUT THAT. WHEREAS ST. LOUIS AND KANSAS CITY MAY GO THROUGH ITS CYCLES, THE SMALLER TOWNS THAT ARE FOCUSED ON PRODUCING SMALLER THINGS, THEY TEND NOT TO HAVE SO MANY ECONOMIC CYCLES OR THE CYCLES TEND NOT TO BE SO PRONOUNCED, YOU KNOW? YOU MIGHT JUST HAVE A SMALL FARMING COMMUNITY THAT'S GROWING FOOD -- A LOT OF MILK, A LOT OF BEEF, A LOT OF PORK, A LOT OF CHICKENS -- AND MAYBE THAT'S IT IN THAT SMALL TOWN. AND WHAT HAPPENS IS, PEOPLE ARE EATING THE PORK AND THE BEEF AND ECO 155 750 LECTURE SIXTEEN 27 DRINKING THE MILK AND SO FORTH DAILY. AND SO THAT SMALL TOWN DOESN'T GO THROUGH THE CYCLES. LET'S TALK ABOUT SERVICES. LET ME JUST DRAW THE GRAPH BEFORE WE GO ANY FURTHER AND THEN I WON'T HAVE TO COME OVER AND DO THIS AGAIN IN A SECOND. SERVICES SORT OF LOOKS THE SAME WAY AS NONDURABLE GOODS -- THAT IS TO SAY, SPENDING ON SERVICES. IT TENDS TO GO UP MORE OR LESS AT A SLOW RATE BUT NOT GOING THROUGH BIG CYCLES. WHAT KIND OF SERVICES ARE WE TALKING ABOUT? WELL, HOW ABOUT A HAIRCUT? HOW ABOUT HAVING YOUR CLOTHES DRY-CLEANED? AGAIN, THESE ARE THINGS THAT DON'T GO THROUGH BIG CYCLES. YOU'RE THINKING, "OH, I NEED TO GET A HAIRCUT. MY HAIR IS GETTING SHAGGY." AND WE DON'T GO, "WELL, THINGS AREN'T LOOKING GOOD DOWN AT THE OFFICE RIGHT NOW. I'M NOT SURE IF I'M GONNA GET THAT RAISE I'VE BEEN COUNTING ON. I'D BETTER NOT GET A HAIRCUT." THEY DON'T SAY THAT. THEY SAY, "OH, A HAIRCUT. YOU KNOW, FIVE OR TEN BUCKS, WHATEVER. JUST GO GET THE HAIRCUT." DRY-CLEANING? "YEAH, I'VE GOT SOMETHING TO TAKE TO THE DRY- CLEANERS." THIS IS NOT SOMETHING YOU CAN REALLY POSTPONE, YOU KNOW -- THE HAIRCUT OR THE DRY-CLEANERS, OR WHATEVER. THESE ARE THINGS THAT YOU NEED TO JUST SORT OF GO ON A DAY-TO-DAY BASIS AND MOST PEOPLE DO. AND THAT BEING THE CASE, THIS IS -- AND ALSO THE AMOUNT OF MONEY INVOLVED IS PRETTY SMALL. AND SO PEOPLE DON'T REALLY TRY AND POSTPONE THAT. THEY MIGHT SAY, "THINGS ARE TIGHT