Download The Cost of Economic Instability

The Cost of Economic Instability
a. Economic Costs
- Stagflation- a period of stagnant growth and inflation at the
same time
o Recession usually brings inflation under control, but this
does not always happen – Example 1970s
- GDP Gap
o the difference between the actual GDP and the Potential
GDP
o Pot. GDP – what could be produced if all resources were
fully employed
o measure of unemployment in terms of output not
produced
- Misery Index
o sum of the monthly inflation and unemployment rates
o measure of consumer suffering during periods of high
inflation and unemployment
- Uncertainty
o worrying about your job in times of declining GDP
o put off purchases
o if a lot of people do this, less production, more lay offs
b. Social Costs
- Wasted resources
o labor wasted because people can not find jobs
o people have a feeling of uselessness and non-productive
- Political instability
o dissatisfied voters will vote out politicians they blame for
the problems
o voters may vote for radical change leading to instability
- Crime
o crime rates often increase
o less people making money, less taxes paid, less money
to pay for police and other services
- Family problems
- less income, more debt, inability to pay debt, bankruptcy
Macroeconomic Equilibrium
a. Aggregate Supply – COST OF PRODUCTION
-AS curve shows the real levels of GDP that would be produced at various
price levels
-Figure 163 (p. 443)
a - b (horizontal range)
o Can increase production by employing more resources at
a relatively low cost, no need to increase price
- b –c (middle range)
o to increase production, employing more resources costs
more, so price has to increase with additional production
- c – d (vertical range)
o cost to increase production high because producers
competing for increasingly scarce resources
o price will increase relatively more for not much increase
in output
Shifts in the AS curve
- Costs of inputs – down, shift to the right – up, shift to the left
- discovering of less expensive natural resources, increases in
labor production, new technologies, lower interest rates, lower
taxes, deregulation
- all would shift it to the right (and vice versa)
-
b. Aggregate Demand- SPENDING
- (Figure 16.4 – p. 444)
- Summary of demand for all economic units in the economy
- AD curve – shows the quantity of real GDP that would be
purchased at each possible price level in the economy
- A change in the price level will move you along the curve
o higher price level, less GDP demanded (and vice versa)
Shifts in the AD curve
- How much people spend instead of save
o Spend more, AD shifts out to the right
o expectations about the future
 expectations are high, may spend more, AD shifts
to the right
o increase in transfer payments (government spending) or
reductions in taxes
 both will increase the amount people have to
spend
 shifts AD out to the right
c. Equilibrium (Figure 16.5 – p. 445)
- Where the AD curve and the AS intersect
- Macroeconomic equilibrium
o The level of real GDP is consistent with a given price
level
o where producers are satisfied to produce at a given price
level and purchasers are satisfied to purchase at a given
price level
Stabilization Policies
- economic growth, full employment and price stability are three
of the major economic goals of the American people
- in order to reach these goals sound economic policy must be
implemented
- many ways to achieve stability
1.
Demand Side Policies
a. Federal policies designed to either increase or decrease aggregate
demand by shifting the AD curve
b. Fiscal policy – the use of government spending and taxing to
influence economic activity
c. Derived from Keynesian economics
A. Keynesian Economics
a. Basic framework
b. C + I + G + F = GDP
c. Of the sectors, (I) was the most unstable and most to blame for
economic instability
d. Government’s role was to step in and offset the changes in
investment sector spending
e. could lower taxes and enact other measures to stimulate spending
by consumers and investors
f. major drawback was the deficits that would be incurred by the
government, but it was believed that the deficits could be
recovered in better economic times
B. Automatic Stabilizers (Government
Spending)
a. Another key component in fiscal policy
b. Programs that automatically trigger benefits if changes in the
economy threaten people’s incomes
c.
Created to provide for Americans but also to ensure that aggregate
demand is propped up during times of low demand in the economy
i. Unemployment insurance
1. Paid for through payroll deductions
2. Get paid 1/3 to ½ your weekly pay – up to 26 weeks
ii. Federal entitlement programs
1. social welfare programs designed to provide minimum
health
2. Ensures demand does not fall below a certain level for
a selected group of people
C. Fiscal Policy and Aggregate Demand
a.
Can shift AD with fiscal policy
b.
Tax cuts or increased government spending can increase AD
and shift to the right
c.
Increase AD will increase GDP but will also increase price levels
D. Limitations of Fiscal Policy
a. Increasing government spending is not difficult, but decreasing
government sending is
b. Planning fiscal policy to offset decreases in investment spending
is almost impossible
c. It takes a long time from planning to implementation of fiscal
policy
a. It could take so long that the spending isn’t needed any
more
2. Supply-Side Policies
a. Economic policies designed to stimulate output and lower
unemployment by increasing production
b. Include a smaller role of the government (than demand-side)
c. Deregulation of industries – less government involvement
d. Less regulations to comply with can low costs, increase supply
A. Federal tax structure
a. higher income taxes make people not want to work as much as
they could
b. lower taxes would give people incentive to work harder and in the
long run have more money to spend (more tax receipts)
B. Supply Side Policies and the AS Curve
a. Policies to increase AS would shift the AS curve out to the right
a. Deregulation
b. Lower Taxes
b. The result would be an increase in GDP and a decrease in price
level
a. THIS IS A PERFECT WORLD! BUT….
C. Limitations
a. Lack of experience with them to know how they affect the
economy
b. The foundation that tax receipts would eventually be recovered
even after reducing tax rates was found to be weak
c. Policy made more to restore economic growth rather than remedy
instability
IN THE SHORT RUN
a. money expansion (fiscal or monetary) can be used to lower
interest rates
b. Lower the cost of borrowing, shift the AS curve to the right
c. This can increase GDP
BUT…
In The Long Run
a. This can lead to inflation
b. how fast should the money supply be allowed to grow?
Growth of The Money Supply
a. Monetarists believe in slow but steady growth
b. Allow the money supply to grow at a rate that is equal to the
anticipated rate of GDP increase plus the rate of productivity (how
much more can be produced this year from last year with same
amount of resources)
c. If GDP up 3% and productivity up 1% then money supply growth
should be 4%
d. Just enough extra money each year to buy the additional goods
and services the economy produces
e. With less money in circulation, inflation would slowly be reduced
Monetary Policy and Unemployment
a. Monetarists argue that attempts to cut unemployment by
expanding the money supply provide only temporary relief
b. Excessive rate of monetary growth drive up prices and interest
rates
c. Higher interest rates raise the cost of borrowing for business
d. This will shift the AS curve in to the left
e. It will also shift the AD curve in to the left
f. Result will be minimal if any gains in GDP but higher price levels
g. Overly expansionary monetary policy will cause inflation in the
long term
h. Monetary policy is not a long term solution for unemployment