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.