Transcript File

Business Cycles: Characteristics and Causes
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The two phases of a business cycle are
recession and expansion.
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A recession begins when the economy
reaches a peak, and ends when it reaches
a trough.
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Expansion is a period of recovery from a
recession.
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Causes of the business cycle include
external shocks, changes in investment
spending, changes in monetary policy,
fiscal-policy shocks, speculation and
“bubbles,” and combinations of several of
these factors.
Business Cycles in the United States
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During the Great Depression, real GDP
declined nearly 50 percent and the number of
unemployed people rose nearly 800 percent.
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Causes of the Great Depression included an
enormous gap in the distribution of income,
easy credit, global economic conditions, and
high U.S. tariffs.
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Reforms established as a result of the Great
Depression include Social Security, minimum
wage, unemployment programs, Securities
and Exchange Commission (SEC), and Federal
Deposit Insurance Corporation (FDIC).
Business Cycles in the United States
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After World War II, business cycles became much more
moderate, with shorter recessions and longer periods of
expansion.
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The Great Recession of 2008-09 was the longest and deepest
recession in the United States since the Great Depression.
Predicting the Next Business Cycle
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Two methods of predicting business cycles are leading
economic indicators and econometric modeling.
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Leading economic indicators include the Dow-Jones Industrial
Average (DJIA) and the leading economic index (LEI).
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An econometric model is a mathematical model that uses
algebraic equations to describe the state of the economy.
Output-Expenditure Model:
GDP = C + I + G + (X – M)
Economic Indicators
● Inflation:
Upward movement in the average levels of prices.
Inflation is contrasted by deflation, which is a
downward movement in the average level of prices
●Unemployment Rate:
The number of people able and willing to work
expressed as a percentage of the labor force. Labor
force includes working individuals and unemployed
individuals but does not include people who do not
want to work
Economic Indicators
● Gross Domestic Product (GDP):
○ The dollar value of all final goods and services
produced by resources located in a country
during a given year. A nominal GDP has not been
adjusted for inflation.
● Percent Change in GDP:
○ A simple calculation that takes the previous GDP
and divides it by the new GDP
■Positive would represent an increase, negative
would represent a decrease
Economic Indicators
● Consumer Price Index (CPI):
○ The measure of the average of a fixed "market
basket" of consumer goods and services that are
commonly bought by households. This statistic is
computed monthly by the Bureau of Labor and
Statistics.
● National Debt:
○ The total amount of money owed by the Federal
Government to the owners of Government
backed securities
The Evolution of Money
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In a barter economy, a mutual coincidence of wants is required
for trade to take place.
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Settlers in Colonial America used commodity money or fiat
money.
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Early paper currency in Colonial America was a form of fiat
money.
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Specie—silver or gold coins—were the most desirable form of
money because of their mineral content and because they were
in limited supply.
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Pesos were nicknamed “talers,” which sounded like “dollars,”
and the term “dollars” became so popular that it became the
basic monetary unit in the U.S. money system.
Characteristics and Functions of Money
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Money must be portable, durable, divisible, and available, but in
limited supply.
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Money plays three roles in the economy: a medium of
exchange, a measure of value, and a store of value.
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Modern money shares the same fundamental characteristics of
all money: portability, durability, divisibility, and scarcity.
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Components of modern money include Federal Reserve Notes,
metallic coins, and demand deposit accounts (DDAs).
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The Fed defines money supply as M1 and M2.
o M1: coins, currency, traveler’s checks, DDAs, checking
accounts
o M2: everything in M1, plus savings deposits, time
deposits, and money market funds
Early Banking in America
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During the Revolutionary War, Continental dollars were printed.
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The Constitution left the printing of paper currency to the
individual states.
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State banks received their operating charters from individual
state governments.
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Problems with pre-Civil War currency included: each bank
printed its own currency, resulting in many different notes;
banks issued too many notes; counterfeiting.
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Congress printed paper money for the first time to pay for the
Civil War.
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The National Banking System was established in 1863,
consisting of national banks that issued currency backed by
federal bonds.
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Other federal currencies included Gold Certificates and Silver
Certificates.
The Gold Standard
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The United States went on the gold standard in 1900, allowing
people to exchange other federal currencies for gold.
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Advantages of a gold standard: people feel secure about
currency and the government does not create too much money,
so the money keeps its value.
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Disadvantages of a gold standard: slowing of the money supply
if gold is scarce and the risk that a people may their convert
currency, depleting the gold supply.
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In 1933, President Roosevelt issued orders denying U.S. citizens
the right to redeem dollars for gold, although foreign countries
could still do so.
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In 1971, President Nixon declared that the U.S. would no longer
redeem any dollars for gold.
Creation of the Fed
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Congress created the Federal Reserve System in 1913 as the
nation’s central bank.
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During the Great Depression, many smaller banks failed.
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In 1933, President Roosevelt declared a bank holiday, during
which all banks were required to close; most were allowed to
reopen after Congress passed legislation to strengthen the
banking industry.
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The Federal Deposit Insurance Corporation (FDIC) was formed
in 1933 to insure customer deposits.
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All other forms of federal currency have now been replaced by
Federal Reserve Notes.
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Our monetary system today is sound and has a uniform
currency, but some banks have become so large that they
cannot be allowed to fail.
Economic Impact of Taxes
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Taxes can affect resource allocation by raising the price of a
product, which makes people buy less, which in turn results in
the company cutting back on production.
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Taxes can be used to encourage or discourage certain types of
activities; sin taxes help raise revenue while discouraging liquor
and tobacco.
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Distribution of income is affected by taxes.
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Taxes change the incentives to save, invest, and work, which
affects productivity and economic growth.
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The incidence of a tax—the person or company who actually
pays it—is not necessarily the entity that is taxed; if a utility is
taxed, for example, it may pass the burden of the tax on to its
customers in the form of higher rates.
Characteristics and Types of Taxes
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The three criteria for effective taxes are equity, simplicity, and
efficiency.
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No single tax has all three of the criteria for effective taxes.
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Taxes in the United States are based on the benefit principle
and the ability-to-pay principle.
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The three types of taxes that exist in the United States today are
proportional taxes, progressive taxes, and regressive taxes.
Alternative Tax Approaches
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Lawmakers want to find new tax revenues that alter the tax
burden.
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A flat tax is proportional to individual income after a threshold is
reached, without exemptions or deductions.
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The advantage of a flat tax is its simplicity, but it would remove
many incentives (such as home ownership) built into the current
tax code.
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A value-added tax (VAT) would tax a product at every stage of
production on a national basis and would be used instead of an
income tax.
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Advantages of a VAT include the difficulty of producers to avoid
paying it, its widely spread incidence, and its ease of collection.
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The main disadvantage of a VAT is that consumers cannot
attribute higher prices to the almost invisible tax.
Tax Reform Highlights
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In 1986, Congress passed a sweeping reform that established
the alternative minimum tax.
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In 1993, top marginal tax brackets of 36 and 39.6 percent were
added to help the government drive down the deficit.
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In 2001, tax law was revised to lower the top four marginal tax
brackets by 2006, introduced a new 10 percent bracket, and
eliminated the estate tax on the wealthiest 2 percent of
taxpayers by 2010.
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In 2003, the government accelerated many of the 2001 reforms
and reduced the capital gains tax bracket.
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In 2013, Democrats in the White House and Senate added two
top tax brackets.
Monetary vs. Fiscal Policy
● Monetary Policy:
○ An Attempt to attain certain economic goals, such as
lowering unemployment, by varying the money supply,
interest, or conditions of credit. The Board of Governors of
the Federal Reserve dictate this policy.
● Fiscal Policy:
○ An attempt to attain certain economic goals, such as
achieving full employment, by varying the government's
purchases of goods and services and its rate of taxation.
This is controlled by Congress and influenced by the
President.
Fiscal Policy
● Fiscal policy is the government's ideas
about spending and taxing
○ Advocates of Fiscal Policy believe that
the way the government spends money
and taxes citizens affects the nation's
GDP
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The belief is that the government is
responsible, through spending and
taxing, for stabilizing the economy
Fiscal Policy
● Expansionary Fiscal Policy
○ Increase in government spending or
decreasing taxes is used when the
economy is "too slow."
When the economy is faced with a
recession, high unemployment and
slow growth of the GDP
○ Looks Like:
■ Increased Government Spending
■ Lower Taxes
■ A combination of the two
Fiscal Policy
●Contractionary Fiscal Policy
○Decreasing government spending or
increasing taxes is used when the
economy is growing too quickly
○Looks like:
■Decreased Government Spending
■Increased Taxes
■A combination of the two
Fiscal Policy
●Fiscal Policy has many underlying effects
○The United States Government
provides many goods and services to
improve life for all classes
■Middle Class
●Increasing money for education
■Lower Class
●Serving as employer of last resort
for low skilled, unemployed
workers; welfare programs
■Upper Class
Fiscal Policy
●Fiscal Policy can be directed to either the
supply-side or the demand-side of
economics
○Supply-side:
■All policies directed at helping the
business and production side of the
economy (changing incentives and
interest rates)
○Demand-side:
■All policies directed at helping the
consumers in the economy (altering
taxes on consumption)