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February 20, 2013

The housing crisis: GDP, housing Bubble and recession – Lesson Plan

By Senior Economics Correspondent Paul Solman

Subject(s)

Economics, Math, Economic History

9-12

Objective

Help students understand the housing bubble and the current U.S. and global economic crisis

Overview

Students will:

• Explore what is GDP and GDP growth
• Look at housing starts as a leading economic indicator
• Debate what makes a bubble
• Review the definition of a recession
• Optional: Learn about bubbles in history, including a stock bubble in the early 1700s, in the shares of a company, run by a Scotsman named John Law called the “Mississippi Company”
• Discuss the value of economic forecasting

Procedure

1. Start the class by playing the first section of Paul Solman’s report on housing.
2. Write the rate of GDP growth for the third quarter of 2006 on the blackboard: 1.6%. GDP grew at a “real” annual rate of only 1.6%, July through September. Note that “Real” means after factoring in any inflation.
3. Next discuss what GDP means: “GROSS DOMESTIC PRODUCT” is how much the economy produces in a given year. “Gross” here means total (as opposed to “disgusting” or “yucky”). “Domestic” means everything produced inside the country, no matter by whom. (So cars being made by a Japanese firm in Ohio count – minus the parts that were shipped from Japan or elsewhere) “Product” means goods and services – everything that has a price and is recorded as sold that year. The President’s salary is included. So is a prison guard’s. But a parent’s hours caring for a baby – or doing the housework – is not, unless someone is paying for it. Another way of putting it: GDP is the total legal sales of the economy in a 12-month period.
4. Next, show how that growth rate compares to previous years: 2005, 2000, the 1990s, the past 100 years.Click here for growth rate chart
5. Ask the question: Now that you know this, how would YOU have predicted which way the economy was going?
6. Introduce another so-called ‘leading economic indicator’: HOUSING STARTS. “Down 30%”
7. Note that a 30% drop knocks a full percentage point off of economic growth. How does that work?
[The answer: 1% of economic growth is 1% of GDP growth, which was roughly 1.6% of \$13 trillion dollars. 1.6% of \$13,000,000,000,000 is what? About \$200 billion. 1% of that: \$2 billion. An average new home cost nearly \$300,000 to build in 2006. A 30% drop meant an anticipated 700,000 fewer homes over the course of the year. 700k x \$300,000 = roughly \$2 billion.]
8. Ask whether knowing the Housing Starts information affects the predictions of where the economy was going in Nov. of 2006? You can remind the class of the definition of a recession: two consecutive quarters of the year in which the GDP actually shrinks. A half-year of what’s called “negative growth.”
9. Does the class agree with a deep recession, as Nouriel Roubini was forecasting?
10. Play the next part of the video in which economic forecaster Ed Yardeni, a longtime Wall Street bull, was asked to listen to Nouriel Roubini, and respond.
11. Ask the class what they think now. Pass out the Shiller ChartAsk: Isn’t it true that the higher prices rise, the harder they fall? How many of you remember the Internet stock bubble?
Optional Primary Source Activity
1. Hand out a selection from the 19th century classic “Popular Delusions and the Madness of Crowds” by journalist Charles Mackay. It describes a stock bubble in the early 1700s, in the shares of a company, run by a Scotsman named John Law. The “Mississippi Company” was given, by the French government, exclusive trading privileges to the great river Mississippi and the province of Louisiana, then owned by France. “The country was supposed to abound in the precious metals.” In addition, early in 1719, the French king also gave the Mississippi Company the exclusive privilege of trading in the East Indies, China, and the South Seas.There is also a William Hogarth image of the “South Sea Bubble”According to an academic study, “The Compagnie share price was around 500 livres in May 1719, rose to nearly 10,000 livres in February 1720, and declined to 500 livres in September 1721.” In other words, similar in scope to the American Crash of ’29.The Mississippi Company went bankrupt that year and John Law had to flee to England.
2. Return to the question: In November of 2006, was the housing bubble bursting, or wasn’t it? Play the next segment
3. Ask what the class thinks now. Note that Ed Yardeni has, for most of his career, been an economic optimist. He uses the acronym GGBAT to describe the era we live in: the Greatest Global Boom of ALL Times.Nouriel Roubini, by contrast, has been warning of a bubble for years.Do you think that colored their views in 2006?
4. Play the rest of the report
5. Ask the class if they think economic forecasting is futile or worthwhile and why.
6. You may choose to end with a quote from economist John Kenneth Galbraith: “There are two kinds of economist: those who don’t know the future, and those who don’t know they don’t know.”

Extension Activities

Students can write an essay on how the financial crisis is affecting them on a personal, community or state level. Send completed essays to extra@newshour.org

• Tags:

Common Core Standards Tooltip of standarts

NCEE Standards
• Standard 1 : Scarcity Productive resources are limited. Therefore, people can not have all the goods and services they want; as a result, they must choose some things and give up others
• Standard 3 : Allocation of Goods and Services Different methods can be used to allocate goods and services. People acting individually or collectively through government, must choose which methods to use to allocate different kinds of goods and services.

Related concepts: Economic Systems, Market Structure, Supply, Command Economy, Market Economy, Traditional Economy
• Standard 4 : Role of Incentives People respond predictably to positive and negative incentives
• Standard 7 : Markets – Price and Quantity Determination Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce goods and services.

Related concepts: Market Structure, Markets, Price Floor, Price Stability, Quantity Demanded, Quantity Supplied, Relative Price, Exchange Rate
• Standard 8 : Role of Price in Market System Prices send signals and provide incentives to buyers and sellers. When supply or demand changes, market prices adjust, affecting incentives.

Related concepts: Non-price Determinants, Price Floor, Price Stability, Supply, Determinants of Demand, Determinants of Supply, Law of Demand, Law of Supply, Price Ceiling, Substitute Good, Price
• Standard 11 : Role of Money Money makes it easier to trade, borrow, save, invest, and compare the value of goods and services.

Related concepts: Exchange, Money Management, Money Supply, Currency, Definition of Money, Money, Characteristics of Money, Functions of Money
• Standard 12 : Role of Interest Rates Interest rates, adjusted for inflation, rise and fall to balance the amount saved with the amount borrowed, which affects the allocation of scarce resources between present and future uses.

Related concepts: Interest Rate, Monetary Policy, Real vs. Nominal, Risk, Investing, Savers, Savings
• Standard 14 : Profit and the Entrepreneur Entrepreneurs are people who take the risks of organizing productive resources to make goods and services. Profit is an important incentive that leads entrepreneurs to accept the risks of business failure.

Related concepts: Taxation, Costs, Costs of Production, Entrepreneur, Risk, Taxes, Cost/Benefit Analysis, Innovation, Entrepreneurship, Inventors
• Standard 15 : Growth Investment in factories, machinery, new technology, and in the health, education, and training of people can raise future standards of living.

Related concepts: Incentive, Interest Rate, Opportunity Cost, Production, Technological Changes, Trade-off, Trade-offs among goals, Human Capital, Intensive Growth, Investment, Physical Capital, Productivity, Risk, Standard of Living, Economic Efficiency, Economic Equity, Economic Freedom, Economic Growth, Economic Security, Investing, Business, Businesses and Households, Factors of Production, Health and Nutrition, Savers, Savings, Stock Market
• Standard 17 : Using Cost/Benefit Analysis to Evaluate Government Programs Costs of government policies sometimes exceed benefits. This may occur because of incentives facing voters, government officials, and government employees, because of actions by special interest groups that can impose costs on the general public, or because social goals other than economic efficiency are being pursued.

Related concepts: Cost/Benefit Analysis, Benefit, Costs, Special Interest Group, Barriers to Trade
• Standard 18 : Macroeconomy-Income/Employment, Prices A nation’s overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy.

Related concepts: Gross Domestic Product (GDP), Macroeconomic Indicators, Nominal Gross Domestic Product (GDP), Per Capita Gross Domestic Product (GDP), Potential Gross Domestic Product (GDP), Real Gross Domestic Product (GDP), Circular Flow
• Standard 20 : Monetary and Fiscal Policy Federal government budgetary policy and the Federal Reserve System’s monetary policy influence the overall levels of employment, output, and prices.

Related concepts: Inflation, National Debt, Tools of the Federal Reserve, Discount Rate, Federal Budget, Fiscal Policy, Monetary Policy, Open Market Operations, Reserve Requirements, Budget, Budget Deficit, Central Banking System, Budget Surplus, Causes of inflation