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11.1 Estimating Gross Domestic Product SLIDE Four Economic Eras of the US Economy 1 1) Before & during the Great Depression 2) After the Great Depression 3) From the early 1970s to the early 1980s 4) Since the early 1980s CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE 2 1) The Great Depression and Before In October 1929 - stock market crashed and began the deepest economic contraction in the nation’s history. CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 3 USA annual real GDP 1910–60, with the years of the Great Depression (1929–1939) highlighted CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE Unemployment rate in the US 1910–1960, with the 4 years of the Great Depression (1929–1939) highlighted CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE 5 Decrease in Aggregate Demand Stock market crash of 1929, grim business expectations A drop in consumer spending Widespread bank failures A sharp decline in the nation’s money supply Severe restrictions on world trade CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE The Decrease of Aggregate Demand Between 1929 and 1933 6 Figure 13.6 CONTEMPORARY ECONOMICS © Thomson South-Western 13.3 Economic Instability SLIDE US industrial production (1928–39) CONTEMPORARY ECONOMICS 7 © Thomson South-Western 13.3 Economic Instability SLIDE 8 CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE 9 Laissez-Faire Before the Great Depression macroeconomic policy was based primarily on this doctrine Laissez-faire— doctrine that the government should not intervene in a market economy beyond the minimum required to maintain peace and property rights CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 10 Laissez-Faire (continued) Doctrine dates back to Adam Smith Wealth of Nations (1776) Argued that if people were allowed to pursue their self-interest in free markets, resources would be guided as if by an “invisible hand” to produce the greatest, most efficient level of aggregate output CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 11 CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 12 The Impact of the Great Depression Severity of the Great Depression stimulated new thinking on how the economy worked 1936 – John Maynard Keynes published The General Theory of Employment, Interest, and Money (most famous economics book of the 20th century) CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 13 John Maynard Keynes CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 14 John Maynard Keynes Argued that aggregate demand was unstable, in part because investment decisions were often guided by the unpredictable “animal spirits” of business expectations. If pessimistic cut investment spending This would reduce aggregate demand Would cut output & employment He saw no natural market forces operating to ensure a return to a higher level of output & employment CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 15 John Maynard Keynes (cont’d) Proposed the government shock the economy out of depression by increasing aggregate demand Government could achieve this directly: By increasing its own spending Government could achieve this indirectly: By cutting taxes to stimulate consumption and investment CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 16 John Maynard Keynes (cont’d) Keynes concluded such federal budget policies would increase aggregate demand. This would shift the aggregate demand curve to the right, back to its original position. Such a shift would raise equilibrium real GDP, which would increase employment. CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 17 CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE 2) From the Great Depression to the Early 1970s 18 Demand-side economics— macroeconomic policy that focuses on shifting the aggregate demand curve as a way of promoting full employment and price stability World War II and aggregate demand The golden age of Keynesian economics CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 19 The Golden Age of Keynesian Economics CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 20 One Problem with Keynes Either influence by the government could create a federal budget deficit A federal budget deficit measures the amount by which total federal spending exceeds total federal revenues. CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 21 3) The Great Stagflation: 1973–1980 During the 1960s, federal spending increased on both the war in Vietnam and social programs at home. This combined stimulus increased aggregate demand enough that in 1968, the inflation rate jumped 4.4% after averaging only 2.0% during the previous decade. Inflation in 1969 4.7% Inflation in 1970 5.3% CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 22 3) The Great Stagflation: 1973–1980 1973 crop failures & OPEC cuts its supply of oil (increases oil prices) This reduced aggregate supply in the economy Stagflation—A decline, or stagnation, of a nation’s output accompanied by a rise, or inflation in the price level Stagflation repeats in 1980 CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 23 3) The Great Stagflation: 1973–1980 Real GDP declined by nearly $40 billion between 1973-1975 Price level jumped almost 20% Unemployment climbed from: 4.9% in 1973 8.5% in 1975 Keynesian demand-management solutions ineffective CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating 13.3 Economic Instability Gross Domestic Product SLIDE 24 Stagflation Between 1973 and 1975 Figure 13.7 CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 25 4) Since the early 1980s Supply-Side Economics The key idea was that cutting tax rates would stimulate aggregate supply. Lower tax rates would stimulate economic growth Government would compensate in the long term (with a larger pie) for short term deficits CONTEMPORARY ECONOMICS © Thomson South-Western 11.1 Estimating Gross Domestic Product SLIDE 26 Giant Federal Deficits Growth in federal spending exceeded the growth in federal tax revenues during this period CONTEMPORARY ECONOMICS © Thomson South-Western