Economic Stability

Economic Indicators  Business cycle  Durable goods purchase  Housing starts  Jobless claims  Consumer price index, Real GNP/GDP  Business cycle  Durable goods purchase  Housing starts  Jobless claims  Consumer price index, Real GNP/GDP

Business cycle Real GNP Peak  Business activity is at it maximum, economy is close to full employment  Recession  Total output of GNP declines  Trough  Output and employment reach their lowest level in the cycle  Recovery  Output and employment expands to full employment Real GNP Peak  Business activity is at it maximum, economy is close to full employment  Recession  Total output of GNP declines  Trough  Output and employment reach their lowest level in the cycle  Recovery  Output and employment expands to full employment

Durable goods  Big ticket items not including houses  Household appliances  Automobiles  Recreational vehicles  Big ticket items not including houses  Household appliances  Automobiles  Recreational vehicles

 Housing starts  Number of housing permits issued  Jobless claims  Decreasing in claims=low unemployment= economic growth  Housing starts  Number of housing permits issued  Jobless claims  Decreasing in claims=low unemployment= economic growth

Index of leading economic indicators  Real GDP  Includes all final goods only  Includes production within our country  Includes foreign companies in our country  Consumer Price Index (CPI)  Measures the price of “market basket” of 30 specific goods that typical consumers purchase  Real GDP  Includes all final goods only  Includes production within our country  Includes foreign companies in our country  Consumer Price Index (CPI)  Measures the price of “market basket” of 30 specific goods that typical consumers purchase

Why is CPI better than GDP?  It ties to common, everyday products people buy  Affect many people  These payments increase when the CPI increases  It ties to common, everyday products people buy  Affect many people  These payments increase when the CPI increases

What goods and services does the CPI cover? The CPI represents all goods and services purchased for consumption by the reference population (U or W) BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups. Major groups and examples of categories in each are as follows:

 * FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks)  * HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)  * APPAREL (men's shirts and sweaters, women's dresses, jewelry)  * TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)  * FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks)  * HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)  * APPAREL (men's shirts and sweaters, women's dresses, jewelry)  * TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

 MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)  * RECREATION (televisions, pets and pet products, sports equipment, admissions);  * EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);  MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)  * RECREATION (televisions, pets and pet products, sports equipment, admissions);  * EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);

 * * OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).  Also included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. In addition, the CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services.  * * OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).  Also included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. In addition, the CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services.

 However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.  The CPI does not include investment items, such as stocks, bonds, real estate, and life insurance. (These items relate to savings and not to day-to- day consumption expenses.)  However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.  The CPI does not include investment items, such as stocks, bonds, real estate, and life insurance. (These items relate to savings and not to day-to- day consumption expenses.)

Problems with Gross Domestic Product Nominal GDP GDP reported in current prices Inflations can distort GDP Real GDP or the GDP expressed in constant dollars Nominal GDP GDP reported in current prices Inflations can distort GDP Real GDP or the GDP expressed in constant dollars

 GDP does not account for population change  Per capita GDP (GDP/total population)  Quality changes are not considered in GDP  Used goods are not included in the GDP  GDP does not account for population change  Per capita GDP (GDP/total population)  Quality changes are not considered in GDP  Used goods are not included in the GDP

 GDP does not include non market production  GDP does not include illegal drugs  GDP does include harmful goods and services  GDP does not include non market production  GDP does not include illegal drugs  GDP does include harmful goods and services

GDP expenditure approach  GDP=C+I+G+NX  C= consumption expenditures by households  I= Spending for new capital good  G= Government purchases of goods and services  NX= net exports (E-I)  GDP=C+I+G+NX  C= consumption expenditures by households  I= Spending for new capital good  G= Government purchases of goods and services  NX= net exports (E-I)

Factors which show returns from GDP  Land  rent  Labor  Wages and salaries  Capital  interest  Management  profits  Land  rent  Labor  Wages and salaries  Capital  interest  Management  profits

Unemployment  Unemployment rate  Divide unemployed workers by the total labor force  % of those in the labor force, over 16, actively seeking work but unable to find jobs.  Unemployment rate  Divide unemployed workers by the total labor force  % of those in the labor force, over 16, actively seeking work but unable to find jobs.

Down fall of unemployment rate  Discouraged workers  People who say they are unemployed, but not really looking for a job  Statistics will show a large increase in total employment, but the unemployment rate will increase at the same time.  Discouraged workers  People who say they are unemployed, but not really looking for a job  Statistics will show a large increase in total employment, but the unemployment rate will increase at the same time.

Types of unemployment  Frictional  Temporary, unavoidable unemployment  Seasonal  Spend part of the year in VOLUNTARY unemployment  Frictional  Temporary, unavoidable unemployment  Seasonal  Spend part of the year in VOLUNTARY unemployment

Types of Unemployment  Structural  Lack of skills to fill the jobs  Cyclical  Economy-wide shortage of jobs  Structural  Lack of skills to fill the jobs  Cyclical  Economy-wide shortage of jobs

Full Employment  Natural rate of unemployment  Frictional and structural unemployment are expected  Actual rate of unemployment = natural rate this is said to be considered FULL EMPLOYMENT  Natural rate of unemployment  Frictional and structural unemployment are expected  Actual rate of unemployment = natural rate this is said to be considered FULL EMPLOYMENT

Fiscal Policy  The use of government ( congress and the President) spending and taxation to stabilize the economy

Expansionary Fiscal Policy  What is happening in a recession?  Consumer spending?  Business spending and investments?  GDP?  What can the government do?  Increase government spending and /or tax reduction.  What is happening in a recession?  Consumer spending?  Business spending and investments?  GDP?  What can the government do?  Increase government spending and /or tax reduction.

Contractionary Fiscal Policy  What is happening in a Inflationary time?  Consumer spending?  Business spending and investments?  GDP?  What can the government do?  Reducing government spending and/or increasing taxes.  What is happening in a Inflationary time?  Consumer spending?  Business spending and investments?  GDP?  What can the government do?  Reducing government spending and/or increasing taxes.

Automatic Stabilizers  Personal income tax  Nations unemployment  Welfare benefits  Personal income tax  Nations unemployment  Welfare benefits

Flaws of fiscal policy  Government revenues decrease with tax reduction  Because of this government may borrow from the public and crowd the market  Problem if government prints currency  Government revenues decrease with tax reduction  Because of this government may borrow from the public and crowd the market  Problem if government prints currency

Monetary Policy  Government (Federal Reserve System) affects interest rates and the quantity of money in circulation

Monetary policy controls the money supply  Open- market operations  Purchase and sale of government securities  When OMC directs FED to buy government securities from banks and other investors it injects money into economy.  When OMC directs FED to sell government securities from banks and other investors it takes money out of the economy.  Open- market operations  Purchase and sale of government securities  When OMC directs FED to buy government securities from banks and other investors it injects money into economy.  When OMC directs FED to sell government securities from banks and other investors it takes money out of the economy.

Monetary policy controls the money supply  Discount rate  The interest rate the FED’s charge banks and other financial institutions on loans  Higher interest rates discourage borrowers  Lower interest rate encourages borrowers  Discount rate  The interest rate the FED’s charge banks and other financial institutions on loans  Higher interest rates discourage borrowers  Lower interest rate encourages borrowers

Monetary policy controls the money supply  Reserve Ratio  The percentage of deposits that banks must hold in reserve  Higher percentage rate less money to loan  Lower percentage rate more money to loan  Reserve Ratio  The percentage of deposits that banks must hold in reserve  Higher percentage rate less money to loan  Lower percentage rate more money to loan

Limitations of Monetary Policy  During rapid expansion Fed may try to hold down spending but consumers and business continue to spend  During recession Fed may try to inject money and consumers and businesses may be afraid to borrow  During rapid expansion Fed may try to hold down spending but consumers and business continue to spend  During recession Fed may try to inject money and consumers and businesses may be afraid to borrow

Monetary vs. Fiscal Policy thought  Adam Smith  “The best thing government could do to help the economy was to keep its hands off. (Invisible hand) The forces of supply and demand would balance.  John Maynard Keynes  It is possible for total supply and demand to be at equilibrium at a point well under full employment. Unemployment would continue unless government stepped in to spend money on public works.  Adam Smith  “The best thing government could do to help the economy was to keep its hands off. (Invisible hand) The forces of supply and demand would balance.  John Maynard Keynes  It is possible for total supply and demand to be at equilibrium at a point well under full employment. Unemployment would continue unless government stepped in to spend money on public works.

Monetary vs. Fiscal Policy thought  Monetarists  Favor the monetary side of the picture  Keynesians  Favor the fiscal side of the picture  Monetarists  Favor the monetary side of the picture  Keynesians  Favor the fiscal side of the picture

Monetary vs. Fiscal Policy  Fiscal policy  Difficult to implement  Monetary policy  Can be changed or adjusted quickly  Fiscal policy  Difficult to implement  Monetary policy  Can be changed or adjusted quickly