Business Cycle & Government interaction in the economy

I. GDP I. GDP : consumption+ govt spending+ investments+ exports – imports. A. Gross Domestic Product (GDP) 1.Dollar value of all final goods and services produced w/in a country’s borders 1.Intermediate goods- used in the production of final goods –not counted in GDP 2.Final goods and services- products in the form sold to customers-Counted in GDP 3.Does not include used goods, or repairs, or recyclables.

B. Gross National Product (GNP)- all of the goods and services produced by Americans in and out of the US. C. Real GDP: GDP adjusted for inflation. D. Per Capita GDP: GDP divided by population.

E. Consumer Price Index (CPI) measures changes in the price level of consumer goods and services purchased by households not including some food and heating oil (because it is too volatile)consumer goodsservices 1.The annual percentage change is used to calculate inflation the rise in the prices of goods and services in an economy over a period of time 2.CPI determines if inflation might be on the horizon. 3.CPI is used to determine the real value of wages salaries, pensions

II. Phases in Business Cycle -Changes in GDP above or below normal levels. Four Phases: A. Peak- when GDP stops rising, the height of economic expansion B. Contraction- an economic decline marked by falling GDP, rising unemployment

1.Recession- prolonged contraction (6-18 months) 2.Depression- long and severe recession with high unemployment, low output C.Trough- economy at lowest point in economic contraction

D. Expansion 1.Period of economic growth as measured by rise in GDP 2.Business prosperity, falling unemployment

Boom or Bust WHAT HAPPENS IN A BOOM? - Businesses produce more goods - Businesses invest in more machinery - Consumers spend more money. There is a FEELGOOD FACTOR - Less money is spent by the Government on unemployment benefits - More money is collected by the Government in income tax and VAT - Prices tend to increase due to extra demand

WHAT HAPPENS IN A RECESSION? - Businesses cut back on production - Some businesses may go bankrupt - Consumers spend less money. Fall in FEELGOOD FACTOR - Individuals may lose their jobs - More money is spent by the Govt on unemployment benefits - Less money is collected by the Govt in income tax and VAT (Value added tax) - Prices start to fall

E.Fiscal policy- gov’t economic policy a.Common fiscal policy in a crisis is lower taxes and increase spending, esp. public transfer payments (entitlements)

Federal Types of taxes: Progressive Tax: the higher the income the higher the percentage paid in income tax ◦ Ex: the Federal Income tax Regressive Tax: The higher the income the lower the percent of the tax is felt on one’s budget. Ex: Sales tax, excise tax ( hits lower income citizens most) Proportional Tax (Flat Tax): Everyone pays the same rate no matter what their income.

III. Unemployment & Poverty 1. Cyclical Employment- unemployment rises during economic downturns and falls when economy improves 2. Full Employment- unemployment rate 4-6% 3. Underemployment- people working at a job in which they are overqualified or part-time

4.Poverty rate- percentage of people who live in households below the poverty threshold (the income a person earns is not sufficient to support a household) 1.One person: $10,590 2.Two adults w/two children: $21,027 for dependents

IV. Government Interventions 1. Entitlement programs 1.Medicaid, Food Stamps, WIC, FDC payments, federal jobs programs & training 2. Gov’t subsidized loans for college education 3. Federal Reserve 1.lowering interest rates so that companies can expand businesses & hire more workers 4. Taxation ◦ Progressive tax rate & Income tax credit

V. Causes of Great Depression A. Investing stocks value $27 billion, stocks value $87 billion 2.Climb encouraged speculation- making investments with borrowed money in hopes of getting big return 3.People were in debt from buying too much on credit.

B. Signs of Trouble from ( ) 1.Large gap between rich and poor 2.Farmers and workers suffering financially once increased production from WWI goes away 3.People going into debt buying consumer goods 4.Overproduction of consumer goods -> Surpluses -> Fall in prices

C. The Crash 1.Overpriced stocks hit peak then began to fall 2.Brokers demand repayment from speculators 3.Black Tuesday (Oct 29, 1929), record 16.4 million shares sold

D. Aftermath 1.Falling prices -> deflation -> unemployment 2.Inaction from the Federal Reserve Bank (currency tied to gold) 1.FDR’s “New Deal” a.Major increase in social programs, public works, gov’t spending b.Stopped contraction but not full recovery 2.WWII- economic recovery

Philosophy on Economic recovery John Maynard Keynes (Keynesian) believed that during a recession the govt should decrease taxes and spend money (stimulate the economy) Increase demand-people have more money will spend it-that gets the economy going Govt should be involved.

Frederick Hayek- Classical/ Supply side economics Milton Friedman: Brilliant economist of Chicago school of economics –Leading economist of the 20 th century Thomas Sowell: Stanford Professor and classical economist Govt should stay out of the economy. Decrease taxes, lower corporate tax rates, decrease spending, reduce regulations. Encourage saving and not people buying on credit

Where do the political parties fall on economics? Liberal view vs. Conservative view Read the handout and you decide what role the govt should play. HR14n8 Milton Friedman and the “Free Lunch Myth” Thomas Sowell “ Fallacies of Class warfare”

Ticket Out: What is a regressive tax, give an example What is a progressive tax, give an example What is a flat or proportional tax?