Chapter 14 – Economic Instability

Section One – Business Cycles and Fluctuations Business Cycle in the United States i. Systematic ups and downs of real GDP a. Phases of the Business Cycle i. Recession – A period in which real GDP declines for two quarters in a row ii. Peak – Point where real GDP stops going up iii. Trough – Point where real GDP stops going down iv. Expansion – A period of recovery from a recession v. If recession and expansion did not occur the economy would follow a trend line vi. A prolonged and severe recession is called a depression

b. The Great Depression i. From 1929 to 1933 real GDP feel from 103 to 55 billion ii. Unemployed went from 1.6 to 12.8 million – up to 25% iii. Average manufacturing wage went from 55 cents to 5 cents an hour iv. Many banks failed v. The money supply fell by 1/3rd

c. Causes of the Great Depression i. Income disparity led to stock market speculation ii. Easy credit iii. American exports fell iv. High tariffs d. Business Cycles Since WWII i. Average recession lasted 11 months while the average expansion period lasted 43 months

II. Causes of the Business Cycle a. Capital Expenditures i. When the economy expands businesses invest in capital goods - build new plants, buy new machinery and equipment ii. When expansion slows down, capital investment decreases b. Inventory Adjustments i. Businesses cut back on inventory at the first sign of recession ii. Businesses expand inventory at the first sign of expansion c. Innovation and Imitation i. Innovation leads to lower costs and higher sales ii. Other businesses must follow suit until further investments prove unnecessary

d. Monetary Factors i. Easy money encourages people to borrow money - economy stimulated for a short time - increased money supply leads to inflation - eventual rise of interest rates decrease borrowing e. Eternal Shocks i. Increases in oil prices, wars, international conflicts

III. Predicting Business Cycles i. An econometric model is a macroeconomics model that uses algebraic equations to describe how the economy behaves ii. Most use some adaptation of the output/expenditure model - GDP = C+I+G+(X-M) iii. Short term economic models have proven their value iv. Index of Leading Indicators

Section Two – Unemployment Measuring Unemployment a. The Unemployment Rate i. People available for work who made an effort to find a job but have not found a job ii. Expressed as an unemployment rate (number of people unemployed divided by the number of people in the workforce) - Data expressed monthly b. Limitations of the Unemployment Rate i. Does not count people who’ve stopped looking for work ii. Does not count people who lose a full-time job and take a part-time job

II. Kinds of Unemployment a. Frictional Unemployment I. Workers who are between jobs b. Structural Unemployment i. A fundamental change in the operations of the economy reduces the demand for a certain type of worker - technology (horse buggies) - consumer tastes or trends - changes in business (mergers) c. Cyclical Unemployment i. directly related to swings in the business cycle - People put off purchases during recessions (automobiles) d. Seasonal Unemployment i. Resulting from changes in weather - construction work - landscaping e. Technological Unemployment i. Workers with less talent or skill are replaced by machines III. The Concept of Full Employment i. Lowest possible unemployment rate - Below about 4.5%

Section Three – Inflation Inflation in the United States a. Measuring Inflation i. Inflation is reported in annual rates of change in the price level ii. Deflation can occur but is rare (Great Depression) b. Degrees of Inflation i. Creeping Inflation – In the range of 1%-3% ii. Galloping Inflation – As high as 100%-300% iii. Hyperinflation – When it’s out of control in the range of 500%

II. Causes of Inflation i. Prices are pulled up by excessive demand ii. Federal Government’s deficient spending iii. Rising input costs drive up the costs of production (labor) iv. Rising cost of non-labor inputs (cost of oil) v. Self-perpetuating spiral of wages and prices vi. Excessive monetary growth

III. Consequences of Inflation i. The dollar buys less (hurts everyone) ii. Leads to decreased purchasing power (hurts elderly) iii. Can cause people to change spending habits (interest rates) iv. Temps people to speculate heavily to take advantage of a higher price level (housing/land) v. Alters the distribution of income (between lenders and borrowers)

Section Four – Poverty and the Distribution of Income i. Lorenz Curve displays income per quintile

II. Reasons for Income Inequality a. Education i. Strong relationship between education and income b. Wealth i. Send your kids to better colleges, make investments c. Discrimination i. Women, minorities in certain industries d. Ability i. Some people (athletes, entertainers, CEO’s) are more talented than others e. Monopoly Power i. Unions / Memberships

III. Poverty a. People in Poverty i. Currently 45-50 million b. The Growing Income Gap i. Change from a production economy to a service economy - Service wages are usually lower than production wages ii. Growing gap between education levels iii. Decline of Unions among low-wage workers iv. Shifts to single-parent families

IV. Antipoverty Programs a. Income Assistance i. TANF (Temporary Assistance to Needy Families) ii. Social Security (Includes disability payments) b. General Assistance i. Food Stamps ii. Medicaid c. Social Service Programs i. Varies state by state (foster care, child abuse prevention, job training)

d. Tax Credits i. Earned Income Tax Credit e. Enterprise Zones i. Areas where companies can locate free of some taxes (usually in rundown areas) f. Workfare Programs i. Requires people on welfare to exchange some labor for their benefits ii. Companies can earn tax credits for hiring the unemployed g. Negative Income Tax i. Make cash payments to groups below the poverty line - encourages people to work - replace other welfare programs