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ECON
NO#14: Problems Faced By All Free Market Economies
Mr. Lua Economics Y-7
Directions--Complete Parts A, B, and C before the day of our next exam:
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Part A (10 Points): As Mr. Lua is talking, please describe OR summarize OR illustrate 5 concepts that he mentioned.
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Part B (10 Points): Create 8 "Checkpoint Questions" about the information below, then answer your own questions.
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Part C (5 Points): Select 5 underlined Key terms below, then write a description, a definition, or create an illustration for each one.
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Part D (Optional 25 Points): Take out a Different sheet of paper and copy everything below, verbatim.
I. Economic Challenges--Overview
A) All free economies deal with three common economic challenges/problems at some point:
1. Unemployment, Poverty, and Inflation
2. All three can have a negative effect on an economy's Gross Domestic Product (NO #12) and prevent an economy from growing
B) All three "challenges" can take place during any of the four phases of the business cycles discussed in NO #13
II. Economic Challenge #1: Unemployment
A) Is it possible for "free market economies" (such as that found in the U.S.) to provide a job for all Americans?
1. No, it is not possible without government intervention.
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Every country with a “free-market economy” experiences different levels of unemployment
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However, economists use two concepts that help them measure the extent to which an economy suffers from joblessness.
2. Concept of Full Employment
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An economy is considered “fully employed” when:
 Unemployment rate is at or below 3.5%
 When the economy's GDP is growing
 When all “factors of production” are being used efficiently.
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“Full Employment" tends to happen during the "expansion phase" of the business cycle
3. Concept of Unemployment Rate
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It is the overall percentage of people that are "unemployed"
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Unemployed = someone that wants a job, is actively searching for a job, but is not able to obtain a job.
 Knowing unemployment rate can help economists judge the health of an economy (just like GDP).
 Four types of unemployment exist: Frictional, Seasonal, Structural, Cyclical
B) Frictional Unemployment
1. Occurs when people VOLUNTARILY take time to:
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Find their first job (the time period after graduation from high school or college, for example)
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Change their existing job and search for a new one.
2. Large economies are guaranteed to have “frictionally unemployed people”
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In many ways having some frictionally unemployed people is a sign of a healthy economy.
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Why? Shows that liquidity exists (having the ability to change jobs and use talents to contribute to the economy in alternative ways)
C) Seasonal Unemployment
1. Occurs when people loose their jobs during certain seasons or time periods of the year.
2. Some industries entirely shut down or reduce production during such periods.
3. They often temporarily/permanently lay off employees.
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Great examples: Malls during Christmas season or migrant farm workers during winter months.
D) Cyclical Unemployment
1. Cyclical Unemployment is unemployment that increases when the economy is shrinking, but decreases when the economy is growing.
2. In other words, cyclical unemployment tends to be high during contraction phases of the business cycle, but low during expansion phases
of the business cycle.
E) Structural Unemployment
1. Structural Unemployment is caused when major shifts (trends, changes) take place in an economy.
2. The United States has experienced 3 major structural changes:
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1776-1880’s: U.S. had an agricultural economy
 90% of all Americans were farmers that produced their own goods & services
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1880’s to 1980’s: U.S. economy became dominated by manufacturing industries.
 Machines made workers more productive in every industry (on farms, in factories, etc) and most of what Americans needed
was produced inside of the U.S.
 The negative result = many farmers lost their jobs & were pushed off of the land, many others that used old production
methods (hand-made shoes, etc) might also have experienced unemployment as they were replaced by machines.
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1980’s to present: Service Economy
 Most job growth in the U.S. today has taken place in “service” types of jobs (doctors, car mechanics, etc).
 Fewer American are involved in manufacturing-related jobs
 A large portion of goods that are consumed by Americans are imported from other countries.
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Main Idea about structural changes: Each time it occurs, jobs are lost until workers learn new skills or adjust.
3. What causes structural unemployment?
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Cause #1: Development of new technology
 When a new invention/technology pushes out older ways of doing things:
 For exp: a growing # of people today use the internet to obtain news information. This is causing massive unemployment in
the newspaper/magazine industry as there is less demand for such products.
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Cause #2 Changes in consumer demand
 When large # of consumers change their demand for a good or service, it always leads to higher unemployment
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Exp: Sardine Snack Industry—In the 1950’s, millions of Americans snacked on Sardines (tiny fish). Since 2000’s,
Americans have eaten fewer sardines for various reasons: changing tastes, to boycott fisherman trapping methods, etc.
Cause #3: Globalization
 Globalization is a process of INTERACTION and INTEGRATION among the people, companies, and governments of
different nations. The internet, fast transportation, international trade, and international investments fuel globalization.
 Example of how globalization can cause unemployment: It is estimated that 70% of all parts that are used to make a Ford F150 truck are made outside of the U.S. American jobs were lost when the Ford Company no longer purchased U.S. parts.
Cause #4 Lack of Education
 People that lack certain levels of education or lack adequate job skills may have a harder time finding employment,
especially during contraction phases of the business cycle when available jobs become scarce.
Cause #5 Discovery of new resources
 For exp: in early 1860’s, millions of Americans burned whale oil in order to light up their homes. When electricity & the
light bulb came into greater use, many fishermen became unemployed.
III. Economic Challenge #2: Inflation
A) Inflation = a general increase in prices of goods & services
1. Inflation can have two major effects:
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Can shrink the purchasing power of money (purchasing power = the value of money, or money's ability to purchase goods & services)
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As prices rise, the purchasing power of money declines.
2. What Causes of Inflation, generally? The following theories attempt to explain why inflation occurs
C) Quantity Theory of Inflation
1. Argues that there is a relationship between the amount of $$$ circulating in an economy and the prices of goods & services sold.
2. In other words, too much $$$ in the economy will cause inflation of price levels.
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For example, if the amount of $$$ circulating in an economy doubles, price levels might also double--which leads to inflation.
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If everyone has easy access to $$$, then competition for goods/services would increase (therefore causing producers increase prices)
D) Demand-Pull Theory of Inflation
1. Argues that inflation occurs when demand for goods and services EXCEEDS existing supplies
2. This type of inflation is the result of strong consumer demand.
3. When many individuals are trying to purchase the same good, the price will unavoidably increase
4. The simple way of remembering the Demand-Pull Theory is with the following phrase:
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It is "inflation caused by too much $$$ chasing too few goods & services"
E) Cost-Push Theory of Inflation
1. This theory says that inflation can occur when two things happen:
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"Something" causes the COST of making a product to be more expensive
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Producers of the product respond by suddenly raising the price of the product.
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In other words, producers pass on additional costs of production to consumers by raising prices.
2. This "something" tends to happen when either:
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Producers are forced to pay their employees higher wages
 For example, a factory owner might pay his workers more if they threaten to strike.
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When the cost of raw materials needed for making the product go up.
 For example, if the cost of pepperoni increases, then Pizza Hut might respond by increasing the price of the entire pizza.
3. "Cost-Push Inflation" can lead to a phenomenon known as "Wage-Price Spiral"
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Wage-Price Spiral = when rising wages causes higher prices, and higher prices causes higher wages.
IV. Economic Challenge #3: Poverty
A) What Is Poverty?
1. Poverty is a situation in which a family's total income is less than the amount required to satisfy its minimum needs.
 A measurement known as the "Poverty Threshold" is used by the federal government to gauge poverty.
2. Poverty Threshold (sometimes called "poverty line") is the income level below which income is insufficient to support a family or household.
 According to the federal government's Department of Health & Human Services, in 2012 a family of 4 needs to earn any amount more than
23,050 to avoid the status of living in poverty.
3. The Poverty Rate is the percentage of people who live in households with a total income below the poverty threshold.
 Government studies indicate that 4 categories of people are currently experiencing high levels of poverty:
 Racial minorities: African Americans & Hispanics are more than twice as likely to be living in poverty than Whites.
 Type of families: families with a single mother have a poverty rate that is almost six times greater than that of two-parent families.
 Age: Young children & young adults have a higher poverty rate than any other age group.
 Residence: People living in "inner cities" (downtown L.A.) or "rural areas" (farming communities) have double the poverty rate than
people living in suburban communities (such as Fontana).
B) What Causes Poverty?
1. Economists agree that there are 5 major causes of poverty.
2. Lack of Education, Location, Racial & Gender Discrimination, Economic Shifts, and Shifts In Family Structure.
C) Please read PGS 345-350 and complete the "Poverty Worksheet" to gain further details regarding poverty, in particular:
1. The Lorenz Curve and the Income Gap