Economic Instability Chapter 14

Economic Cycles The economy is up and down throughout our history A good economy always comes to a halt before it takes off again The GDP is the most important factor in determining if the economy is good or bad

Phases of the Business Cycle Two phases of the business cycle: 1) recession = period during which the real GDP declines for two quarters/6 months It begins when the economy reaches a peak (high point of GDP) It ends when the economy reaches a trough (low point of GDP)

2) expansion = period of recovery from a recession It begins when the GDP reaches its low point and begins to turn around If a recession becomes very severe, it could become a depression = state of the economy with large numbers of people out of work, acute shortages and excess capacity in manufacturing plants The Great Depression in the 1930’s was the only depression in the 20th century

Causes of the Great Depression Several factors brought on the Depression: 1) big gap between rich and poor Poor couldn’t help economy because they had no money to spend Rich didn’t help economy because they often used it in the stock market 2) Too much credit (borrowing)

3) Too many European countries not repaying loans or getting loans 4) High tariffs on imports hurt world trade 5) too many consumer goods produced 6) overproduction of agriculture = falling prices

The Great Depression Stock Market crashed on Oct. 29, 1929 Many went from rich to poor in days Even people with no stocks were hurt because their savings were in banks that failed Between 1929 and 1933, GDP fell from $103 billion to $55 billion Employment rose to 25% Money supply fell by 1/3

At first gov’t did nothing, expecting the crisis would solve itself When FDR was elected, he instituted the New Deal which put millions to work in public works projects This provided relief for people but did NOT end the Depression The massive amount of gov’t spending during WWII ended the Depression

Unemployment Unemployed = people who try to find work, and worked less than one hour for pay Unemployment rate = the # of unemployed divided by the total number of civilian laborers Unemployment rates rise dramatically in recessions and drop slowly afterwards

Kinds of Unemployment Frictional unemployment = workers who are between jobs for some reason These workers don’t suffer much economic hardship Structural unemployment = occurs when a big change in the operations of the economy reduces the demand for workers Changes in technology or consumer demand can bring this about Industries may change the way they do business

Cyclical Unemployment = unemployment directly related to swings in the business cycle. Example: during a recession, people don’t buy as many consumer goods As a result, some industries lay off workers until the economy recovers Seasonal Unemployment = unemployment resulting from changes in the weather or changes in demand for certain products. Example: home builders don’t work as much in cold weather

Technological Unemployment = unemployment caused when workers with less skills, talents or education are replaced by machines Example: numbers of bank tellers reduced because of automated teller machines Full Employment = the lowest possible unemployment rate – reached when it drops below 4.5% Hard to maintain because of business cycles

Inflation Inflation = rise in prices related to an increase in the supply of money, resulting in a loss in the value of currency Terms that describe the severity of inflation: Creeping inflation = in the range of 1 to 3% per year Galloping inflation = as high as 100 to 300% Many Latin American and former communist countries experience this Hyperinflation = in the range of 500% or more Very rare and signals a total monetary collapse Record set by Hungary during WWII 828 octillion (27 zeros) pengos equaled 1 prewar pengo

Causes of Inflation 1) when all sectors of the economy try to buy more goods and services than the economy can produce 2) huge deficit spending on the part of the government 3) rising input costs, especially labor, drive up cost of products for manufacturers 4) increase in cost of nonlabor inputs Example: rise in prices of a barrel of oil

5)self-perpetuating spiral of wages and prices Example: higher prices force workers to ask for higher wages In turn, producers try to recover that cost with higher prices It creates a spiral 6) most popular explanation is excessive monetary growth Occurs when the money supply grows faster than the GDP Extra money created by the Fed will increase some groups purchasing power Spending that money drives up prices

Consequences of Inflation 1) most obvious effect is the dollar buys less The purchasing power of the dollar falls as prices rise so the dollar loses value over time 2) inflation can cause people to change their spending habits which disrupts the economy 3) it tempts some people to speculate heavily in an attempt to take advantage of a higher price level Example: buying luxury items like diamonds and gemstones because they may increase in price

4) it alters the distribution of income During long periods of inflation, lenders are hurt more than borrowers Loans made earlier are repaid in inflated dollars Example: A person borrows money from you to buy bread at .50 cents a loaf They borrow $100 dollars so they can buy 200 loafs If inflation sets in and the price of a loaf rises to $1 by the time the loan is repaid to you Then when you get your money back, you could only buy 100 loaves for the same amount

Reasons for Income Inequality There are several reasons the incomes of various groups may be different 1) Education: Usually people with higher education make more income because they have a higher level of skill 2) Wealth: Income varies because some people have more wealth than others

3) Discrimination: It is illegal, but still takes place Women may not be promoted to executive positions Unions may deny ethnic minorities membership When this occurs, women and men are driven into other labor markets where oversupply drives down wages

4) Ability: 5) Monopoly Power: Some people have a natural ability Like athletes and movie stars who make millions 5) Monopoly Power: The monopoly power that some groups hold Unions get higher wages for members American Medical Association limits enrollment in med schools to limit amount of doctors

Poverty = relative measure that depends on prices, the standard of living and a low measure of income In US, income must be below $23,550 for a family of four Poverty rate was 12.5% when Obama took office It has been 15% for 3 years now In 2013, almost 50 million Americans lived in poverty More than 2/3 are white and almost ¼ are African American Poverty

A major reason for the continued high poverty level is the growing gap in the distribution of income There are several causes: 1) change in the economy as industry changes from producing goods to services Wages are lower in grocery stores and amusement parks 2) gap between well-educated and poorly educated workers 1990’s wages for highly skilled workers soared while less skilled wages stayed the same

3) decline of unions (especially among low-skilled workers) Many now have to work elsewhere for less pay 4) changing structure of the American family There has been a shift from two-parent families to single-parent families This usually lowers incomes

Antipoverty Programs The government has created welfare programs to help the needy Welfare = economic and social programs that provide regular help from the gov’t or private agencies because of need Temporary Assistance for Needy Families – 1997 – families get cash payments because of death, continued absence or permanent disability of a parent Supplemental Security Income – cash payments to blind or disabled over 65

General assistance programs do not give cash Food Stamps = gov’t issued coupons that can be redeemed for food Medicaid = federal-state medical insurance program for low-income people Social service programs: Child abuse prevention Foster care Job training

Enterprise Zones: Workfare Programs: These are areas where companies can locate free from some local, state and federal tax laws and other operating restrictions Usually in run down or very low income areas Workfare Programs: Many state and local gov’ts require people who receive welfare to provide labor in exchange for benefits Sanitation crews Highway crews