Economic Modeling
CSCI 1210
Spring 2004
“It’s the Economy, Stupid!”
--Political consultant
James Carville
 What are the key
economic issues?
 Can we model the
major influences on
the economy?
 How do policy
choices affect these
factors?
Why Political Economics is Hard
 Inherent
complexity
 Limitations of theory
 Political spin doctoring
 Deliberate obfuscation
Jobs and the Economy

Creation of all kinds of jobs is important
 Manufacturing jobs were a key focus of the
Edwards campaign
 What is your prospect of getting a job that
satisfies you and pays well?
Federal Budget deficits
Social Security and Medicare
Intergenerational Equity
Modeling failure or political
blarney?
2002
1999
1995
1992
1989
1986
1982
1979
1976
1973
1969
1966
1963
1960
1956
1953
1950
1947
Economic Growth
US Nominal GDP, 1947-2003
12000
10000
8000
6000
4000
2000
0
Economic growth and the Deficit
“I owe $50,000. Should I worry?”
 Answer:
it depends on your projected
future income!
 Deficits are best measured as a
percentage of Gross Domestic Product
(GDP)
 Budget deficit and trade deficit are both
important
Ways of measuring GDP
 Nominal
GDP: total dollar amount
 Real GDP: adjusted for inflation
 Per capita GDP: production per person
 Per capita real GDP
See the “Economic growth” spreadsheet for
examples
Fundamental production flow

Total production
(GDP) divided into
consumption and
investment.
 Labor, capital and
technology are the
factors of
production
 Investment increases
the stock of capital
Fundamental production flow
 Total
production = Gross Domestic
Product (GDP)
 Production divided into consumption and
investment
 Investment adds to capital stock
 Production investmentmore
production: positive feedback loop!
Supply-side economics

Increasing investment is most effective way to
increase production
 Target tax cuts to high-income taxpayers, who
are more likely to invest
Keynesian economics

Aggregate demand:
total willingness of the
economy to buy stuff
 Government can
influence aggregate
demand by spending
and tax policies
 Aggregate demand is
main control for
production
Keynesian economics

Increased government spending adds to
aggregate demand
 Target tax cuts to lower-income people, who are
more likely to spend it
Original Social Security System

Social Security was originally a pay-as-you go
system
 Since 1933, worker payroll taxes have paid
retirees
Social Security Trust Fund

In 1983, payroll taxes were increased to provide
a surplus trust fund for baby boomer retirement
 The surplus is held in US Government bonds
 The surplus revenue is spent by US Govt
 Surplus is counted as US Govt income, not part
of deficit
A Basic Model of Job Creation

Productivity = how much output by each worker
 Number of workers x productivity = total output
 If output rises faster than productivity, new jobs
are created
Jobs and unemployment

Labor force participation is the percentage of
people who are working or looking for work
 The US economy must create 150,000 jobs per
month just to keep up with population growth
 To reduce unemployment, need more jobs!
Labor Force Participation

Older people are
working longer than in
the past
 Either they enjoy it…
 Or don’t have much to
do…
 Or can’t afford to
retire!
Labor Force Participation

Fewer young people
are working than in
the past
 More students staying
in school longer
 Is it because they
can’t find jobs?
Why have job models failed?
Factors often left out of
standard models:
1. Distribution of
income (effects
aggregate demand)
2. International trade
(globalization)
Systems thinking about the
economy
 How
do we explain long-term growth with
fluctuations (the business cycle)?
Systems thinking about the
economy
 Long-term
growth suggests a positive
feedback loop (investment – production)
 Oscillations suggest negative feedback
with delay – where is it?
Delayed negative feedback?

The explanation of business cycles is
controversial. Here is one possibility:
Cambell McConnel, Economics: Principles, Problems and Policies 7th ed. P.
217
Delayed feedback example
1.
2.
3.
4.
5.
6.
An entrepreneur opens a disco roller rink
nightclub in Athens
The club is a big hit!
Three other local entrepreneurs plan
disco roller rink nightclubs
A few months later, there are 4 clubs
All four clubs, sharing the market, lose $
A few months later, 2 clubs close
Projecting the Future: CBO
How to Lose $8 Trillion
 Congressional
Budget Office (CBO)
predictions used to project Federal budget
 Note curves ‘flatline’ out – they are
guesses of average future values
 Experiment: go back to spreadsheet,
adjust GDP growth rate down 1%. What is
total difference over 15 years?
How to Lose $8 Trillion
 Early
2001: Bush Administration projects a
cumulative Federal budget surplus of
$5.6 trillion over 2001-2011 time period
 September 2003 – projected cumulative
budget deficit of $2.3 trillion over 20012011 time period
Source: Dizzying Dive to Red Ink Poses Stark Choices for Washington by David Firestone. New
York Times, Sept 14, 2003
“A Fall Worthy of Milton”
“It really was the perfect fiscal storm.” – Joel
Prakten, Macroeconomic Advisers

Projected surplus was based on stock-market bubble
 Effects of recession
 Effects of 9/11 attacks
 Effects of tax cuts
“[I]t was hard when staring at the surplus to
argue that there shouldn't be a tax cut” -Robert D. Reischauer, former CBO director
Acknowledgements

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


Tax revenue chart: http://www.getamericaworking.org
Budget deficit projections: http://www.reachm.com/amstreet/archives/000120.html
Social security charts: http://mwhodges.home.att.net/soc_sec.htm
Wishful thinking on jobs: http://www.commondreams.org/views04/0309-08.htm
John Maynard Keynes image: http://www-groups.dcs.st-and.ac.uk/~history