How does the government work to ensure that free markets are free and that consumers benefit from competition?

Government Regulation of Competition Maintaining Economic Competition: Markets work the best when there are lots of buyers and lots of sellers. This fosters competition which is good for consumers. Monopolies – market controlled by one business. Often results in high prices and low quality products. - Sherman Anti-trust Act (1890) – banned illegal business combinations and monopolies - The government has used the Sherman Anti-trust Act several times to prevent a single business owner from controlling prices and products. JP Morgan’s Northern Securities in 1904 John D. Rockefeller’s Standard Oil in 1911 AT&T in 1974 Microsoft in 2004

Government Regulation of Competition Natural monopolies – LEGAL: Local utilities like water, electricity, natural gas, cable, etc. – Competition isn’t efficient, so businesses are allowed to be monopolies but are heavily regulated by the govt. to ensure proper market practices. Oligopolies – market control by a few – LEGAL - Car manufacturers, oil companies, etc.

Government Regulation of Competition Mergers – combination of businesses LEGAL as long as the merger does not create a monopoly. The govt. can prevent a merger that will cause one. Food Lion in NC - Vertical- merge different levels/stages of production. Ex: Hog farm & trucking company - Horizontal – merger of “like” companies for efficiency. Ex: BellSouth/Cingular/SBC/AT&T - Conglomerates – merger of various businesses for profit Ex: GE – electricity, insurance, real estate, NBC

International Trade One way for the government to promote competition is ensure easy interstate and international trade. When there are more available products and more businesses, consumers are usually better off. Why do countries specialize? Certain countries are very good at producing certain products and terrible with others. The US can’t produce bananas. Most developing countries can’t produce airplanes and cars.

International Trade Economic Interdependence: No person or nation is truly self-sufficient. We must rely on each other (people and nations) to produce all of the things we want and need. Effects of Interdependence: Environmental and Political problems in one country can cause economic problems in many other countries. Governments must enact policies that allow their citizens access to products made in other countries.

International Trade Policies Free Trade Agreements: Nations can legally agree that they will limit or prevent trade between the two nations. NAFTA EU Free Trade Issues: Companies can more easily move their factories to another country. Domestic businesses may be hindered by increased trade with foreign companies

International Trade Policies Protectionist Trade Policies: Many nations limit imports to protect domestic producers of the same product. Tariffs: Taxes on imports - Make prices for the imported goods more expensive Quotas: Limits on the number of specific goods that can be imported. Ex: Japanese Cars

How can we determine how the economy is doing overall, and what does government do to try to help when things are not going well?

The Business Cycle Phases of the business cycle: The economy goes through regular fluctuations where sometimes things are very good, and sometimes they are very bad. Peak: highest phase - prosperity and low unemployment. Economy “expands”  more goods and services produced Trough: lowest phase - high unemployment / decreased business activity. Economy “Recedes/shrinks”  fewer goods and services produced

Business Cycle continued… Recession: Downward phase; declining GDP for at least 6 months/ 2 quarters. Depression: prolonged (several years) period of no growth or decline. No specific definition. Causes of business cycles Political and social upheavals (war, election, etc.) Increase or decrease in consumer confidence

Business Cycle

Prosperity-Peak  Full capacity  New business  Employment high Business Cycle

Contraction-Recession Business Cycle Prosperity  Decline in production  Spending decreasing

Depression-Trough  Lowest Point  Spending at all time low  Excess economic capacity  Unemployment high Business Cycle prosperity contraction depression

Expansion Business Cycle Prosperity Contraction depression expansion  Spending begins to increase  Recovery  Unemployment decreases

Economic Indicators Forecasting business cycles: Gross domestic product: the total value of all goods and services sold in a nation in a year. Does not measure changes in quality US GDP: $14.62 Trillion - China: $5.75 Trillion, Japan: $5.39, Germany: $3.3, India $ Per Capita GDP: GDP per person  good indicator of Standard of Living. US: $47,100, China: $4,300 - Real GDP: adjusted for inflation Housing starts/Consumer spending: more new houses = good Less spending = bad Unemployment rates Inflation Stock Market

Unemployment Measures of Employment - employed: actively working - unemployed: those who do not have a job and ARE seeking work. - not in labor force: persons without jobs NOT seeking work - Civilian Labor Force: All people 16 or older in a nation who are working or looking for work. Unemployment Rate: Percentage of people in CLF who are not working - The unemployment rate tends to rise quickly in recessions and fall slowly in expansions.

Inflation Measuring inflation - Consumer Price Index  survey of the change in price of 400 commonly bought products in the country. If the price of items has gone up on average, we are experiencing inflation. A general rise in prices the value of the dollar decreases

Effects of Inflation creditors - paid back in devalued dollars (BAD for creditors) Wage/salary increases – must match inflation cost of living increases benefits such as Social Security must be indexed to the CPI

Stock Market Individuals buy pieces of ownership in corporations called stocks - Stockholders make money two ways 1) Receive a portion of the company’s profits based on their percentage of ownership  Dividends 2) Sell stocks at a higher price than they were bought for  capital gains Stocks go up or down in price because people are willing to pay more or less money for them. This decision is based on assumptions about how well the business will do in the future. Stock Indexes: look at general trends of many stocks Ex: Dow Jones Industrial Average; S&P Stock Indexes tend to be good indicators of how confident people are in the economy.

Government’s Role in the Economy Providing Public Goods: the government provides many goods and services to consumers that are not provided by private businesses. Private goods – consumed by only 1 person, only bought by one person. You must directly pay for it to use it. - Pizza, t-shirts, lamps Public goods – consumed by many. You can use it without paying for it each time. Govt. provides these because they are seen as necessary but it is difficult to get people to pay for them. - Libraries, parks, street lights, roads

More Government Involvement Government Safety Net - Externalities – unexpected side effects of economic activity - Govt. provides public goods for positive externalities. They also unintentionally cause a positive externality  computer chips - Govt. also works to prevent negative externalities, especially pollution caused by businesses Protecting consumers/environment Advertising/product safety: ensures that companies are truthful (Federal Trade Commission) and are producing safe products (FDA) - Recall – removing/changing a dangerous product

What actions can be taken by the government to affect the economy?

Fiscal Policy Adjusting govt. taxing and spending to address economic downturns. In theory, the best thing to do in a recession is to both cut taxes and increase govt. spending. Why cut taxes? This gives people more income to spend, which will hopefully stimulate the economy due to increased demand Why increase govt. spending? Provide more jobs to unemployed people, so they have more money to spend.

Fiscal Policy, cont. Cutting taxes AND increasing spending is impossible without putting the nation into serious debt. So, we usually have to pick one. This issue is one major difference between Democrats and Republicans. - Democrats prefer to increase govt. spending hoping to employ more people and encourage them to spend their income. - Republicans prefer to cut taxes hoping to stimulate investment in the economy from the top which will result in more jobs being created.

Problems with Fiscal Policy Because Fiscal policies are set by the Congress, it often takes a long time for them to take effect. The Congress often has trouble making quick decisions because of the different perspectives /interests of members. Both possible actions also assume that people will spend the extra income that they receive. If they choose to save their money instead, the economy will not be stimulated.

The Federal Reserve & Monetary Policy The Federal Reserve (The “Fed”) serves as the nation’s central bank. It is designed to oversee the banking system. It regulates the quantity of money in the economy.

The primary elements in the Federal Reserve System: The Board of Governors The Regional Federal Reserve Banks The Federal Open Market Committee The Federal Reserve & Monetary Policy

Monetary policy is conducted by the Federal Open Market Committee. The money supply refers to the quantity of money available in the economy. Monetary policy is the setting of the money supply by policymakers in the central bank. The Fed works to affect the economy by changing the supply of money. More money tends to stimulate the economy Less money tends to slow the economy The Federal Reserve & Monetary Policy

The Fed’s 3 Tools of Monetary Control 1. Open-Market Operations (OMOs): purchase and sale of U.S. government BONDS  To increase money supply, Fed buys govt bonds, paying with new dollars. …which are deposited in banks, increasing reserves …which banks use to make loans, causing the money supply to expand.  To reduce money supply, Fed sells govt bonds, taking dollars out of circulation, and the process works in reverse.

3 Tools, cont. 2. Reserve Requirements (RR). Affect how much money banks can loan versus how much they must keep IN RESERVE  To increase money supply, Fed reduces RR. Banks make more loans from each dollar of reserves, which increases money multiplier and money supply.  To reduce money supply, Fed raises RR, and the process works in reverse.  Fed rarely uses reserve requirements to control money supply: Frequent changes would disrupt banking.

3. The Discount Rate: the INTEREST RATE on loans the Fed makes to banks  When banks are running low on reserves, they may borrow reserves from the Fed.  To increase money supply, Fed can lower discount rate, which encourages banks to borrow more reserves from Fed.  Banks can then make more loans, which increases the money supply.  Banks can give loans at lower interests rates, which encourages businesses and consumers to borrow and spend money  To reduce money supply, Fed can raise rate. 3 Tools, cont.

Effects of Monetary Policy The Fed most commonly uses Open Market Operations (buying and selling bonds) to affect the supply of money. If the economy is doing poorly, the Fed uses Monetary policies to attempt to stimulate the economy. If the economy is doing really well, the Fed uses Monetary policies to slow things down. This prevents inflation and hopefully prevents a massive over-correction like we saw in 2008.

Effects of Monetary Policy Monetary Policy is often more effective then Fiscal Policy in the short-term because the Fed can enact policies immediately. The Fed is also independent of the Congress, so they can make decisions that are more unpopular with voters, because they cannot be voted out of office. This is potentially good for the economy, but not so good for a democracy.