Economics 5/23/11 OBJECTIVE: Demonstration of Chapter#12 and begin examination of the business cycle. I. Administrative Stuff -attendance & distribution of test II. Chapter#12 Test III. Journal #32 pt.A -Examine the cartoon p.343 -Answer the caption question p.343 -Examine Figure Answer the caption question p.345 IV. Journal #32 pt.B -notes on the business cycle

This week Chapter#13 section#1 Chapter#14 section#1 Chapter#14 section#3 Chapter#13&14 Test is Friday!

The Business Cycle Business cycle - the rise and fall of GDP over time. GDP – Gross Domestic Product GDP= C+I+G+(X-M) C – consumer I – business G – government X – exports M - imports

Phases of the Business Cycle Ch#14 sec#1 p.376

The Recession Phase of the Business Cycle There are two phases of the business cycle Recession – when real GDP declines for two quarters in a row (6 months) A recession begins following a peak Peak – the point where GDP stops going up A recession ends at a trough Trough – the turnaround point where GDP stops going down.

The Expansion Phase of the Business Cycle Expansion – period of recovery from a recession. Expansion begins at the trough of the business cycle. Expansion ends when the business cycle reaches a new peak. Since WWII, the average recession lasted 11 months. The average expansion lasted 43 months. The expansion that began in March 1991 & almost ended in March 2001 is the longest in history. (1 st and 3 rd quarters of 2001 GDP dropped)

CPI

US Real GDP

US Real GDP

US Real GDP

Real GDP v. Unemployment

GNP v. GDP GDP- the dollar value of all final goods and services produced within a country’s national borders in a year. GNP- the dollar value of all final goods, services, and structures produced with labor and property supplied by a countries residents.

Depression If a recession becomes very severe, it may turn into a depression A depression is a state of the economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plants Between 1929 and 1933, GDP declined nearly 50% and unemployment rose 8 times!

Depression Currency was in such short supply that towns, counties, chambers of commerce, and other civic bodies resorted to printing their own money, known as depression scrip Several factors contributed to the Great Depression One was the disparity in the distribution of income Easy and plentiful credit also appears to have played a role Global economic conditions also played a part as American tariffs on imports kept many countries from selling goods to the United States

Economics 5/24/11 OBJECTIVE: Examine of the business cycle. I. Journal #33 pt.A -Questions on Econ U.S.A. episode#3 II. Quiz#19 III. Return of Chapter#12 Test IV. Journal #33 pt.B -notes on the business cycle

Econ U.S.A. episode #3 1.) Why was Congress unable to determine the true severity of the Great Depression? 2.) What was the result of this problem? 3.) How did the U.S. Government prepare economically for WWII? 4.) How does government spending affect the circular flow? 5.) How did the environmental concerns of the 1970’s effect the economy? 6.) How does the government know if the policies they enact have helped the economy?

This week Chapter#13 section#1 Chapter#14 section#1 Chapter#14 section#3 Chapter#13&14 Test is this Friday!

Figure 13.3 Circular Flow of Economic Activity

The End of the Depression Massive government spending during World War II added a huge stimulant to the economy for most of the early 1940s Recession returned in 1945, but it did not last As soon as the war was over, consumers went on a buying binge that stimulated expansion again Since 1965, there has been a recurring pattern of recessions and expansions After 1980, however, recessions occurred less frequently The expansion that began in 1991 is the longest expansion in United States history

Why Business Cycles? No one theory seems to explain past business cycles, or serves as a way to predict future ones Changes in capital expenditures are one cause of business cycles When the economy is expanding, businesses expect future sales to be high, so they invest heavily in capital goods After a while, businesses may decide they have expanded enough and they begin to pull back on their capital investments

Inventory Adjustments & Innovation Inventory adjustments, or changes in the level of business inventories, are a second possible cause of business cycles Some businesses cut back on inventories at the first sign of an economic slowdown and then build them back up again at the first sign of an upturn When a business innovates, it often gains an edge on its competitors because its costs go down or its sales go up The imitating companies must invest heavily to do this, and an investment boom follows

Monetary Policy A fourth possible cause of business cycles is the credit and loan policies of the Federal Reserve System When “easy money” policies are in effect, interest rates are low and loans are easy to get Eventually the increased demand for loans causes interest rates to rise, which in turn discourages new borrowers As borrowing and spending slow down, the level of economic activity declines

Shocks A final potential cause of business cycles is external shocks, such as increases in oil prices, wars, and international conflict Some shocks drive the economy up, as when Great Britain discovered North Sea oil in the 1970s Other shocks can be negative, as when high oil prices hit the United States in the early 1970s

Economics 5/25/11 OBJECTIVE: Examine of the effects of monetary policy on the business cycle & types of inflation. I. Journal #34 pt.A -Read “Business Week Newsclip” p.362 -Answer questions (1-2) p.362 II. Journal #34 pt.B -notes on the business cycle III. Journal #34 pt.C -notes on the Commanding Heights (episode#2 day#2)

Shocks A final potential cause of business cycles is external shocks, such as increases in oil prices, wars, and international conflict Some shocks drive the economy up, as when Great Britain discovered North Sea oil in the 1970s Other shocks can be negative, as when high oil prices hit the United States in the early 1970s

Inflation Inflation is a special kind of economic instability, one that deals with changes in the level of prices rather than the level of employment and output To better understand inflation, we must first examine how it is measured Then we can examine the causes of inflation and its consequences In order to find inflation, we start with the price level, the relative magnitude of prices at one point in time To measure the price level, economists select a market basket of goods

CPI They then construct a price index such as the consumer price index (CPI), the producer price index, or the implicit GDP price deflator Prices tend to rise faster during expansions and then slow down during recessions On rare occasions, unusual circumstances may cause deflation, or a decrease in the general price level

The Rate of Inflation Figure 14.5

Types of Inflation Creeping inflation - inflation in the range of 1 to 3 percent per year Galloping inflation - a more intense form of inflation that can go as high as 100 to 300 percent When inflation gets totally out of control, hyperinflation - inflation in the range of 500 percent a year and above–occurs

Causes of Inflation Nearly every period of inflation is due to one of the following causes First explanation demand-pull theory - all sectors in the economy try to buy more goods and services than the economy can produce As C + I + G converge on stores, shortages occur and prices go up

Causes of Inflation Second explanation - federal government’s deficit - blames inflation only on the federal government’s deficit spending Third explanation claims that rising input costs (cost push)–especially labor–drive up the cost of products for manufacturers and cause inflation

Causes of Inflation Still another explanation says that no single group is to blame for inflation According to this view, a self-perpetuating wage/price spiral of wages and prices begins that is difficult to stop The final and most popular explanation for inflation is excessive monetary growth This occurs when the money supply grows faster than real GDP Inflation cannot be maintained without a growing money supply to fuel it

Consequences of Inflation When inflation is present, it can have a disruptive effect on an economy for several reasons The most obvious effect of inflation is that the dollar buys less

Consequence of Inflation Decreased purchasing power is especially hard on retired people with fixed incomes because their money buys a little less each month A second destabilizing effect is that inflation can cause people to change their spending habits, which disrupts the economy A third destabilizing effect of inflation is that it tempts some people to speculate heavily in an attempt to take advantage of a higher price level Finally, inflation alters the distribution of income During long inflationary periods, lenders are generally hurt more than borrowers Loans made earlier are repaid later in inflated dollars

Economics 5/26/11 OBJECTIVE: Examine the Role of the Federal Reserve. I. Journal #35 pt.A -Read “The Global Economy” p.420 -Answer questions (1-3) p.420 II. Quiz#20 III. Journal #35 pt.B -questions on Fed Film: What should the Fed do? NOTICE: Chapter#13&14 Test Tomorrow!

The Role of the Fed Main goal of the Fed Open Market Committee…control inflation How can the Fed control inflation? 1.) Change the interest rate 2.) Change the reserve requirement 3.) Open Market Operations - Buy or Sell securities (bonds) *buy – increases the money supply *sell – decreases the money supply

Fed Video 1.) What is the role of the Fed? 2.) What causes inflation? 3.) What happened to the cost of a bagel when the money supply was increased? 4.) How does the Fed determine the money supply? 5.) Why do people spend money when inflation hits? 6.) What were fears of the Fed if inflation continued to rise? 7.) What portion of the money supply is in the form of cash and coins?

8.) What was the prime rate in 1980? 9.) What did this rate do to the housing and auto industry? 10.) What happened to the unemployment rate when the money supply shrank? 11.) What happened to the inflation rate? 12.) What happened to the unemployment rate in 1984? 13.) What role does the Federal Reserve District President play? 14.) How has the Globalization of the economy effected the role of the Fed?

Economics 5/27/11 OBJECTIVE: Demonstration of Chapters#13&14 and begin examination of Monetary Policy. I. Administrative Stuff -attendance & distribution of test II. Chapter#13&14 Test III. Journal #36 pt.A -Read “Profiles in Economics” p.414 -Answer questions (1-2) p.414 IV. Journal #36 pt.B -notes on monetary policy

Ben Bernanke 14 th Chairman of the Federal Reserve Board of Governors Assumed office 2/1/06

Monetary Policy Monetary policy – the expansion or contraction of the money supply in order to influence the cost and the availability of credit. In English, when the Fed raises interest rates the amount of money in the economy gets smaller. When the Fed lowers interest rates, the amount of money in the economy gets bigger. Higher interest rates encourage people to save money. Lower interest rates encourage people to spend and borrow money.

Structure of the Fed

How does the Fed influence interest rates? Fractional reserve system – requires banks and other depository institutions to keep a certain percentage of their deposits on hand as legal reserves. Legal reserves – consists of coins and currency held in the bank’s vault and the currency it has on deposit with the Federal Reserve. The Fed requires that banks keep a reserve of 12% against demand deposit accounts.

How Banks Operate You deposit $100 in your savings account. The bank MUST keep 12% of that $100 on reserve. (They must keep $12) The bank loans out the other $88. If the person who borrows the money puts it in a checking account, the $88 is treated as a new deposit and 12% or $10.56 of it must be set aside as a reserve. The other $77.44 can now be loaned out. This is the multiplication of the money supply.

Example of Fractional Reserve at 20% Ch#15 sec#2 p.419

Tools of Monetary Policy If the Fed wants the money supply to grow they can do the following: 1.) Lower the interest rate 2.) Lower the reserve requirement 3.) Buy securities (buy bonds) This is known as easy money policy.

Tight money policy If the Fed wants the money supply to contract, or slow they can do the following: 1.) Increase the interest rate 2.) Increase the reserve requirement 3.) Sell securities (sell bonds) This is known as tight money policy.

Tight money policy

The Role of the Fed Main goal of the Fed Open Market Committee…control inflation How can the Fed control inflation? 1.) Change the interest rate 2.) Change the reserve requirement 3.) Open Market Operations - Buy or Sell securities (bonds) *buy – increases the money supply *sell – decreases the money supply

M1 v. M2 The main difference is function! M1, represents the transactional components of the money supply, or the components of the money supply that most closely match money’s role as a medium of exchange M2 is a measure of money that includes those components most closely conforming to money’s role as a store of value M2 includes M1, small denomination time deposits, savings deposits, and money market funds

M1 & M2 Figure 15.9