Transcript Chapter 15 Economic Instability

Business Cycles
A business cycle is a macroeconomic period of expansion
followed by a period of contraction.
• A modern industrial economy experiences cycles of
goods times, then bad times, then good times again.
• Business cycles are of major interest to
macroeconomists, who study their causes and effects.
• There are four main phases of the business cycle:
expansion, peak, contraction, and trough.
• Businesses reduce their capital expenditures when they
decide they have expanded enough.
• At the first sign of an economic slowdown, they cut
back inventories, cut back working hours, and start
laying off workers. New investment is cancelled.
• Government money policy can also affect the cycle.
• External shocks, like war or an increase in oil prices,
can cause business cycles.
Business Cycle Phases
Expansion--a period of economic growth as measured by
a rise in real GDP. Economic growth is a steady, longterm rise in real GDP.
Peak--when real GDP stops rising, the economy has
reached its peak, the height of its economic expansion.
Contraction--Following its peak, the economy enters a
period of contraction, an economic decline marked by a
fall in real GDP. A recession is a prolonged economic
contraction. It is usually defined as GDP decline for
TWO successive quarters. An especially long or severe
recession may be called a depression.
Trough--is the lowest point of economic decline, when
real GDP stops falling.
4 Variables that Keep the
Business Cycle Going
• Business Investment--When an economy is expanding,
firms expect sales and profits to keep rising, and
therefore they invest in new plants and equipment. This
investment creates new jobs and furthers expansion.
In a recession, the opposite occurs.
• Interest Rates and Credit--When interest rates are low,
companies make new investments, often adding jobs to
the economy. When interest rates climb, investment
dries up, as does job growth.
• Consumer Expectations--Forecasts of a expanding
economy often fuel more spending, while fears of
recession tighten consumers' spending.
• External Shocks--External shocks, such as disruptions
of the oil supply, wars, or natural disasters, greatly
influence the output of an economy. WAR is bad for
markets!
Forecasting Business Cycles
• Economists try to forecast, or predict,
changes in the business cycle.
• Leading indicators are key economic
variables economists use to predict a
new phase of a business cycle.
• Examples of leading indicators are stock
market performance, interest rates, and
new home sales.
Business Cycle Fluctuations
The Great Depression
– The Great Depression was the most severe downturn
in the nation’s history.
– Between 1929 and 1933, GDP fell by almost one
third, and unemployment rose to about 25 percent.
Later Recessions
– In the 1970s, an OPEC embargo caused oil prices to
quadruple. This led to a recession that lasted through
the 1970s into the early 1980s.
U.S. Business Cycles in the 1990s
– Following a brief recession in 1991, the U.S. economy
grew steadily during the 1990s, with real GDP rising
each year. In late 2000, as the Clinton
administration was leaving, the US began to enter a
recession that Bush has been blamed for.
Remedying the Business Cycle
• The Government can try to regulate the
business cycle by applying Keynesian
Economics.
• John Maynard Keynes handout
• But there is a lag—Congress cannot agree on
a stimulus package, partisan bickering
• You almost have to pass a job creation
stimulus package DURING GOOD TIMES. Of
course, the risk then becomes inflation. Now
do you want Alan Greenspan’s job?
Section Review—Business Cycles
1. A business cycle is
(a) a period of economic expansion followed by a
period of contraction.
(b) a period of great economic expansion.
(c) the length of time needed to produce a product.
(d) a period of recession followed by depression and
expansion.
2. A recession is
(a) a period of steady economic growth.
(b) a prolonged economic expansion.
(c) an especially long or severe economic contraction.
(d) a prolonged economic contraction.
Types of Inflation
Creeping Inflation
• Creeping inflation is inflation that remains low (1 to
3 percent) for a long time.
Chronic Inflation
• Chronic inflation occurs when the inflation rate rises
steadily from month to month over an extended
period.
Hyperinflation
• Hyperinflation is inflation that is growing out of
control. Inflation rates may be as high as 100 or
even 500 percent. Hyperinflation can sometimes
lead to total economic collapse. EX: Germany 1923
Deflation is where prices fall. It’s negative inflation.
Causes of Inflation
• Quantity Theory-- states that too much money in the
economy leads to inflation. Adherents to this theory
maintain that inflation can be tamed by increasing the
money supply at the same rate that the economy is
growing.
• Cost-Push Theory--Inflation occurs when producers
raise prices in order to meet increased costs. Cost-push
inflation can lead to a wage-price spiral — the process
by which rising wages cause higher prices, and higher
prices cause higher wages.
• Demand-Pull Theory--states that inflation occurs when
demand for goods and services exceeds existing
supplies.
But what explains
“Stagflation?”
• During Nixon administration,
“Stagflation” occurred.
• It was the combination of inflation with
no economic growth.
• The inflation theories do not account for
this possibility—but it did happen.
Effects of Inflation
High inflation is a major economic problem, especially
when inflation rates change greatly from year to year.
• Purchasing Power--In an inflationary economy, a dollar
loses value. It will not buy the same amount of goods
that it did in years past. Some people start speculating
and their purchasing drives prices even higher. It’s like
a stock market full of short sellers.
• Interest Rates--When a bank's interest rate matches
the inflation rate, savers break even. When a bank's
interest rate is lower than the inflation rate, savers lose
Real money.
• Income--If wage increases match the inflation rate, a
worker's real income stays the same. If income is fixed
income, or income that does not increase even when
prices go up, the economic effects of inflation can be
harmful. The elderly take a beating.
Inflation Group Check-up
Questions
• Define inflation precisely.
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What are the effects of rising prices?
How is the inflation rate calculated?
What are the three types of inflation?
What are the causes and effects of inflation?
Who wins and who loses because of inflation?
Section Review--Inflation
1. Inflation is
– (a) the process by which rising wages cause higher
prices.
– (b) the price increase of a typical group of goods.
– (c) a general increase in prices.
– (d) the ability to purchase goods and services.
2. Chronic inflation occurs when the inflation rate
– (a) drops to zero.
– (b) remains low for a long time.
– (c) grows out of control.
– (d) rises steadily over an extended period.
Poverty
The Census Bureau collects data about how many
families and households live in poverty.
The Poverty Threshold
• The poverty threshold is an income level below
which income is insufficient to support a family or
household. $16,000 for a family of 4.
• The Poverty Rate
• The poverty rate is the percentage of people in a
particular group who live in households below the
official poverty line. 13% of Americans are poor.
Yet, the poorest Americans are often better of than
the average person in a 3rd world country
Poverty: Focus Questions
• Who is poor, according to government
standards?
• What causes poverty?
• How is income distributed in the United States?
• What government programs are intended to
combat poverty?
• Should these programs be discontinued or
reformed?
Causes of Poverty
• Lack of Education--The median income of high-school
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dropouts in 1997 was $16,818, which was just above the
poverty line for a family of four.
Location --On average, people who live in the inner city
earn less than people living outside the inner city.
Shifts in Family Structure--Increased divorce rates result in
more single-parent families and more children living in
poverty. Dan Quayle: “Marriage is probably the best antipoverty program of all.”
Economic Shifts--Workers without college-level skills have
suffered from the ongoing decline of manufacturing, and
the rise of service and high technology jobs.
Racial and Gender Discrimination--Some inequality exists
in wages between whites and minorities, and men and
women.
Differences in wealth lead to differences in income.
Income Distribution
Income Inequality
• The Lorenz Curve illustrates income distribution.
Income Gap
• A 1999 study showed that the richest 2.7 million
Americans receive as much income after taxes as the
poorest 100 million Americans.
• Differences in skills, effort, and inheritances are key
factors in understanding the income gap. Monopoly
power also allows some groups, like doctors and
lawyers, to maintain high incomes.
The Lorenz Curve
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The Lorenz curve was developed by Max O. Lorenz
as a graphical representation of income inequality. It
can also be used to measure inequality of assets or
other distributions.
In economics, we frequently make statements such
as, "the bottom twenty percent of all households
have five percent of the total income". The Lorenz
curve is based on such statements; every point on
the curve represents one such statement.
The Lorenz curve is a graph that shows, for the
bottom x% of households, the percentage y% of the
total income which they have..
A perfectly equal society would be one in which
every person has the same income. In this case, the
bottom N% of society would always have N% of the
income. Thus a perfectly equal society can be
depicted by the straight line y=x; we call this line the
line of perfect equality.
A perfectly inequal society, by contrast, would be one
in which one person has all the income and everyone
else has none. In that case, the curve would be at
y=0 for all x<100, and y=100 when x=100. We call
this curve the line of perfect inequality.
It is impossible for the Lorenz curve to rise above the
line of perfect equality, or sink below the line of
perfect inequality.
The Lorenz curve is used to calculate the Gini
coefficent.
Government Programs that Fight Poverty
• Employment Assistance--the minimum wage and federal and
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state job-training programs aim to provide people with more job
options.
General Assistance—food stamps
Welfare Reform--The 1996 Welfare Reform Act (PRWORA):
Temporary Assistance for Needy Families (TANF) is a program
which gives block grants to the states, allowing them to
implement their own assistance programs. Workfare programs
require work in exchange for temporary assistance. There is a 5year limit on the receipt of benefits.
Enterprise Zones—provide jobs in poor neighborhoods by
encouraging companies to set up shop in low-tax or no-tax
zones.
Social Service Programs—provide assistance with family
planning, child abuse prevention and other problems affecting
low income people
Section Review--Poverty
1. An income level below which income is insufficient to
support a family or household is known as the
– (a) income gap.
– (b) poverty rate.
– (c) poverty threshold.
– (d) income inequality.
2. The Personal Responsibility and Work Opportunity Act
of 1996
– (a) provides lump sums of money to poor families.
– (b) provides federal payments to poor families to
supplement state payments.
– (c) set a 5-year limit on receipt of benefits.
– (d) provides direct cash payments to poor families.