The Federal Government Influences the Nation’s Economy

Government and the Economy Capitalism-(aka free enterprise system) Economic system in which the means of production and distribution are privately owned.

Adam Smith

The Free Market The Wealth of Nations by Adam Smith (1776) The government should stay out of economic decisions (laissez faire). The “invisible hand” of free competition would improve everyone’s life Expanded ideas of supply and demand

The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good.

Law of Demand

The law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied.

Law of Supply

Law of Demand

Law of supply and demand

-“What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?” -“The real tragedy of the poor is the poverty of their aspirations” -“Man is an animal that makes bargains: no other animal does this - no dog exchanges bones with another.” -“Virtue is more to be feared than vice, because its excesses are not subject to the regulation of conscience.” - “Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow- citizens.”

Smith believed inflation, or when price of goods rises rapidly (decrease in $ value), was a minor inconvenience compared with advantages of free market system.

Government Involvement Interstate Commerce Act in 1887 Sherman Antitrust Act of 1890

Depression Era Policies Economic Depression- a condition in which widespread unemployment, idle factories, business stagnation, farm foreclosures, bank failures, and other problems continue for a year or more (Great Depression of the 1930’s) Recession- low business activity and high unemployment rate. (Characterized by a fall in Gross Domestic Product for two consecutive quarters) GDP- the total amount of goods produced and services provided in a country during one year nominal

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* Deficit Spending- means that the government’s expenditures exceed its revenues This theory was developed by British economist John Maynard Keynes in his General Theory of Employment, Investment, and Money (1936)

Postwar Changes There is typically a recession after a “war-time economy” Employment Act of 1946 was meant to prevent a recession (maintain “maximum employment, production, and purchasing power.”) It requires the president to submit an annual Economic Report Also established the Council of Economic Advisors.

FISCAL POLICY Fiscal policy is way of influencing the economy by deliberately changing level of taxing and spending Three important theories of fiscal policy have influenced the American economy in recent times: Keynesian economics, supply-side economics, and fiscal conservatism.

Keynesian Economics Best way to manage the economy is to influence the demand for goods, mainly by controlling revenue (increase public expenditure/ take money out of economy by cutting federal spending or increasing taxes). Keynesians maintain belief that it is not necessary to balance the federal budget every year, as long as the economy is healthy.

Supply Side Economics Developed by Herbert Stein in 1976 Concentrate on increasing the supply of goods and services. Tax cuts will give incentive to work harder and invest with the money earned/ saved. With the population making more money, it will generate more taxes and offset the tax cuts

Fiscal conservatism The goal of fiscal conservatism is a balanced budget, that is, keeping government spending at the same level as tax revenues. Increase taxes, decrease federal spending, or both

Monetary policy Monetary policy- a governmental tool for influencing the economy by varying the amount of money in circulation and people’s ability to borrow money

Federal Reserve System, or the Fed was created in 1913 to control monetary policy Seven Board members serve for fourteen years. One board member is appointed chairperson for four year terms.

Monetary Policy Options The fed has four basic ways to create monetary policy 1.Buy and sell government securities (takes money out of circulation) 2.Regulate the discount rate- the rate of interest charged to member banks when they borrow from the Federal Reserve 3.Alter the reserve requirement, or the percentage ration of reserves to loans 4.Margin requirements – percentage of money people can legally borrow to buy stock