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Factors that Influence the Business Cycle
Supply shocks - unexpected disruption in
the economy that causes shifts in prices,
economic activity, and employment.
Examples of good supply shocks...
new microchip technology that lowers the costs of
computer technology
exceptionally good growing season
elimination of import tariffs
Factors that Influence the Business Cycle
Examples of bad supply shocks…
terrorist attacks
labor strikes
droughts
oil embargoes
wars that disrupt imports
direct effects on specific market -- ripple effects
on other markets -- affect the whole economy
Factors that Influence the Business Cycle
The Federal Reserve - central bank in the
U.S. whose Board of Governors is
appointed by the president with consent of
the Senate. The Fed…
protects the solvency of the banking system
promotes commerce
The Fed controls the money supply
Manipulating Interest Rates
The r that the Fed charges banks for short-term
loans
Changing bank reserve requirement
% of dollar deposited banks must keep
Changing bank reserves
Buying and selling Treasury securities
Factors that Influence the Business Cycle
With respect to the money supply, the Fed can
decrease interest rates (which increases money
supply)
which in the short run (i.e., <12 mths)…
• increases economic activity
• increases employment
• increases household income
which in the long run (i.e., > 12 mths)…
• increases inflation
Factors that Influence the Business Cycle
With respect to the money supply, the Fed can
increase interest rates (which decreases money
supply)
which in the short run (i.e., <12 mths)…
• decreases economic activity
• decreases employment
• decreases household income
which in the long run (i.e., > 12 mths)…
• decreases inflation
A note on Wealth and Labor from Adam Smith
(reference Reading Packet)
“Every man is rich or poor according to the
degree in which he can afford to enjoy the
necessities, conveniences, and
amusements of human life.”
Our own labor can only do so much for us;
we need others’ labor to bring us the joys
of life.
Wealth is determined by how much labor
we command, either our own labor or
others
The value of any commodity is equal to
the quantity of labor which is required to
possess it.
The “REAL” Price
 “The real price of every thing, what every thing really
costs to the man who wants to acquire it, is the toil and
trouble of acquiring it.”
 What we buy with money, we are really buying with our
labor
 “Labor was the first price, the original purchase-money
that was paid for all things. It was not by gold or silver,
but by labor, that all the wealth of the world was originally
purchased;”
Using labor to measure prices
 Gold, silver and money always have varying values.
One cannot use a commodity to measure another
commodity if the values are continually changing.
 However, equal quantities of labor are of equal value to
the laborer. The price paid (labor) is always the same.
 Labor is alone the ultimate and real standard by which
the value of all commodities can be compared.
 Labor is the real price, money is their nominal price only.
Measuring Labor
Although labor should be the real measure
of the value of all commodities, it is difficult
to ascertain between two different sorts of
work.
The market sets the value of the different
labors by bargaining.