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2
Government and the
Economy
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Chapter Objectives
• Diagram and explain the four parts of the
business cycle.
• Compare and contrast recession, inflation,
and stagflation.
• Describe how the government uses fiscal
and monetary policy to combat inflation
and recession.
• Explain the economic consequences of
government taxing and spending.
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Chapter Objectives
• Explain how the national debt hurts the
economy.
• Describe the government’s role in
promoting competition.
• Identify the laws and government agencies
that protect consumer interests.
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Economic Conditions
Monitored by the Government
• The business cycle
– Contraction: period of slow or no growth
– Trough: end of a contraction
– Recovery: period when business activity
begins to grow again
– Peak: height of recovery
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Recession and Depression
• Recession
– Extended period of slow or no economic
growth
– Two or more quarters of negative growth
• Depression
– Occurs when a recession lasts several
years or more
– Example: The Great Depression of the
1930s
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Recession and Depression
• Depression is characterized by
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high unemployment
decline in retail sales
lowered average personal incomes
decreases in consumer spending
reduced spending by businesses
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Inflation
• Inflation threatens
the nation’s
prosperity
• Today’s dollars
buy less than last
year’s dollars
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Inflation
• Demand-pull inflation
– Occurs when the economy is growing
– As demand goes up, prices go up
• Cost-push inflation
– Triggered by price increase of a widely
used good, such as oil
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Stagflation
• Stagflation is a period of slow growth
and high inflation
• Best example occurred in the 1970s
– Raised oil prices triggered inflation
– Slow economic growth, high
unemployment
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In Your Opinion
• What types of goods and services
would likely cost more following
increases in the price of oil?
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Impact of Unemployment and
Underemployment
• Full use of productive resources,
including labor force, ensures prosperity
and stability
• Unemployment hurts workers, families
• Unemployment rate rises during periods
of slow growth and contraction
• Government policies impact
unemployment
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Impact of Unemployment and
Underemployment
• Types of unemployment
– Frictional—job loss among workers
temporarily between jobs
– Structural—job loss among people whose
skills are not in demand; long-term
– Cyclical—job loss during economic contraction
– Seasonal—job loss among people holding
temporary seasonal jobs
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Underemployment
• Underemployment occurs when
– people want to work full-time but can
only find part-time work
– people settle for jobs requiring fewer
skills and/or education than they possess
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Factors Affecting Economic
Policies
• Economic goals of government
– Moderate the ups and downs of business
cycles
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Factors Affecting Economic
Policies
• Other economic goals of government
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Increase economic growth and prosperity
Increase employment
Keep inflation low
Insure proper balance of trade in world
markets
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Fiscal Policy
• Fiscal policy, which is determined by
the U.S. Congress, can
– stimulate the economy in periods of
recession and high unemployment
– slow economic activity in periods of
inflation
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Gross Domestic Product
• Gross domestic product (GDP) measures
economic growth and includes
– consumer spending
– investments by
businesses
– net exports of
goods and services
– government
spending
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Gross Domestic Product
• Real GDP is GDP adjusted for
inflation
– Drop in GDP indicates weakening
economy
– Rise in GDP indicates economic growth
– Unexpected spurt can indicate future
inflation
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Consumer Price Index
• Consumer price index (CPI)
– Measures the movement of prices for a
bundle of select goods and services
– Used to calculate cost-of-living increases for
• members of labor unions
• those receiving Social Security and pension
benefits
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Fiscal Policy During Recession and
Inflation
• During recession, fiscal policy is
aimed at increasing the amount of
money in circulation
• Government does this by
– increasing government spending
– lowering taxes so people have more
money to spend
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Fiscal Policy During Recession and
Inflation
• During inflation, fiscal policy aimed at
decreasing the amount of money in
circulation
• Government does this by
– decreasing government spending
– increasing taxes so people have less
money to spend
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Monetary Policy
• Monetary policy
refers to actions by
the Federal Reserve
Board (Fed) to change
the supply of money
• Fed regulates the
nation’s money
supply and banking
system
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Monetary Policy
• Federal Reserve System consists of
– Federal Reserve Board, headed by a
chairperson
– 12 Federal Reserve Banks across the
country
– Federal Open Market Committee
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Reserve Requirements
• Fed requires that banks and other
financial institutions set aside a
percentage of their total deposits
– High reserve requirement reduces
amount of money banks have to lend
– Low reserve requirement increases
amount of money banks have to lend
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Discount Rate
• Fed sets the interest
rate commercial
banks must pay for
credit
– Fed tends to lower
discount rate during
economic slowdown
– Fed tends to raise
discount rate during
periods of inflation
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Open Market Operations
• Fed buys or sells Treasury securities
(bonds, notes, bills)
– Fed increases money supply by buying
securities (puts dollars into circulation)
– Fed decreases money supply by selling
securities (takes dollars out of circulation)
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Easy Versus Tight Money
• Easy monetary policy speeds up the
economy because
– interest rates are relatively low
– more credit is available
– consumers borrow and spend more,
increasing demand
– businesses borrow and spend more,
creating growth and new jobs
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Easy Versus Tight Money
• Tight monetary policy slows down
the economy because
– interest rates are relatively high
– less credit is available
– consumers borrow and spend less,
decreasing demand
– businesses borrow and spend less,
resulting in fewer jobs
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Easy Versus Tight Money
• Manipulating the economy is difficult
– The U.S. is part of a complex global
economy with many interconnected parts
– It often takes months for policies to bring
about desired changes
– Solving one problem can cause others
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Taxing and Spending
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Taxing and Spending
• Government buys goods and services
from producers/sellers; capital from
consumers
• Producers/sellers and
consumers/workers pay taxes and
receive programs, goods, and services
from government
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Taxing and Spending
• Tax revenues pay for
– government operations
– services that private citizens cannot do
– items that private citizens do not
produce
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Redistribution of Income
• Government redistributes income
through
– progressive taxes (higher-income citizens
pay a higher rate of tax)
– transfer payments (tax revenues pay for
some financial assistance and benefits to
certain individuals)
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Deficit Spending and the
National Debt
• Deficit spending
occurs when
government spends
more than it receives
in revenues each year
• Surplus is created
when government
receives more than it
spends
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Deficit Spending and the
National Debt
• Excess spending and borrowing
increase the national debt
• Government must pay interest on the
amount owed; leaves less money to pay
for other needs
• Taxpayers pay for the national debt in
the form of increased taxes
• Debt threatens future economic growth
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Government Regulations
• Government involvement in the
economy is growing
• Government regulation affects local,
state, and federal levels
• Regulations seek to
– promote fair competition
– ensure public well-being and safety
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Fair Competition
• Perfect competition is when many
buyers and sellers exist
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Fair Competition
• Competition among multiple sellers
results in
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lower prices for consumers
better service
greater innovation
most efficient allocation of resources
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Fair Competition
• Monopoly is when a single seller
exists; seller can control price and
supply
• Oligopoly is when a few large sellers
exist; sellers can control price to a
lesser extent than in monopoly
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Fair Competition
• Lack of competition hurts consumers
and the economy
• Government’s anti-trust laws
– prohibit monopolies
– prohibit price fixing and collusion
– prohibit other unfair and deceptive trade
practices
– promote competition and fair trade
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The Public’s Well-Being and
Safety
• Regulations
require
– equal
opportunity
– fair labor
practices
– workplace safety
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The Public’s Well-Being and
Safety
• Regulations also require
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environmental protection
pure foods, drugs, and cosmetics
product safety
truth in advertising and labeling
truth in lending and savings
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Costs of Regulation
• Regulations are costly because they
– create extra work and costs for businesses
– put businesses at competitive disadvantage
with unregulated businesses
– create extra work and costs for government
(and citizens through taxes)
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Government Agencies Serving
Consumers
• Department of
Agriculture
(USDA)
– Food safety, food
production,
nutrition
education,
international trade
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Government Agencies Serving
Consumers
• Department of Energy (DOE)
– Promotes the development of reliable,
affordable, and clean energy sources
• Department of Labor (DOL)
– Enforces labor laws, advances
employment opportunities, provides
labor statistics
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Government Agencies Serving
Consumers
• Department of Health and Human
Services (HHS) includes
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Centers for Medicare & Medicaid
Office of Public Health and Science
National Institutes of Health
Centers for Disease Control and
Prevention
– Food and Drug Administration
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Government Agencies Serving
Consumers
• Food and Drug
Administration
(FDA)
– Enforces food
safety; regulates
drugs, tobacco
products,
cosmetics
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Government Agencies Serving
Consumers
• Social Security Administration (SSA)
– Manages retirement, survivors, and
disability insurance and supplemental
security income programs
• Dept. of Housing and Urban Dev. (HUD)
– Promotes fair housing, home ownership
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Government Agencies Serving
Consumers
• Consumer Product Safety Commission
(CPSC)
– Enforces safety of consumer products
• Federal Trade Commission (FTC)
– Regulates advertising, promotes competition
• Securities and Exchange Comm. (SEC)
– Regulates security exchanges, protects
investors from fraud
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Government Agencies Serving
Consumers
• U.S. Department of the Treasury
– Collects taxes, pays nation’s bills, regulates
banks, investigates financial crimes
• Federal Communications Commission
(FCC)
– Regulates communications by telephone,
television, radio, cable, wire, and satellite
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Central Ideas of the Chapter
• The goal of government economic policies
is to create economic stability and
prosperity for its citizens.
• Government enacts laws and regulations to
ensure fair competition and to protect the
public well-being and safety.
• Government agencies at all levels assist and
protect consumers by providing
information, protection, and services.
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