Econ: Business Cycle, Monetary Policy, and Fiscal Policy

Government Sector

- Includes all local, statism and federal levels of government - Receives income from infest business taxes, corporate income taxes, Social Security contributions, and individual income taxes

Inflation

- Increase in the general level of prices of goods and services

Open Market Operations

- Sales or purchases of U.S. government securities by the Fed - Fed's most popular tool - Allows the fed to influence short-term interest rates - Contractions: buy government securities - Expansion: sell government securities

Price Index

- Statistical series used to measure changes in the price level over time

Resource allocation

- Tax placed on a good or service at the factory rises the cost of production and the price of a product - People react by buying less

Limitations of GDP

- Tells us nothing about the composition of output - Tells us little about the impact of production on the quality of life - Some GDP is produced to control activities that give us little utility or satisfaction, thus making GDP even larger - Ex: Crime

Board of Governors

- The Fed is directed by a seven-member Board of Governors - Appointed by Prez and approved by Senate - 14 year term - A regulatory and supervisory agency - Sets general policies for its member banks to follow and regulate certain aspects of state-chartered member bank's operations - Makes policies that affect level of interest rates and the general availability of credit - Reports annually to Congress and puts out a monthly bulletin that covers national and international monetary matters

Fiscal Policy

- The government's power to tax and spend to get a stagnant economy moving again or to address inflation - Does this trough taxes, government spending - These budget matters are decided by Congress and approved or vetoed by the President - Taxes: contraction: decrease taxes Expansion: Increase taxes - Government spending: Contraction: increase government spending Expansion: decrease government spending

National Income

- The income that is left after all taxes except the corporate profits tax are subtracted from NNP

Interest rate

- The price of credit to a borrower

Advisory Committees

- Three advisory committees advise the board of Governors - The Federal Advisory council consists of the 12 district banks and provides advice to the Federal Reserve on mattes concerning the overall health of the economy - The consumer advisory council's 30 members meet with the Board three times a year to advise on consumer credit laws - Thrift Institutions Advisory Council, with representatives from savings and loan associations, saving banks, and credit unions. Advise on matters pertaining to the Savings and Loan industry

Unemployment

- Unemployed: working for less than one hour per week for pay or profit in a non-family-owned business, while being available and having made an effort to find a job during the last month

Seasonal unemployment

- Unemployment cause by annual changes in the weather or other conditions that reduce the demand for jobs - Construction in the winter

Technological Unemployment

- Unemployment cause by technological developments or automation that makes some workers' skills obsolete

Structural Unemployment

- Unemployment caused when economic progress, a change in consumer tastes and preferences, or a fundamental change in the operations of the economy reduces the demand for workers and their skills - Outsourcing

Cyclical Unemployment

- Unemployment directly related to swings in the business cycle

Frictional Unemployment

- Unemployment involving workers changing jobs or waiting to go to new ones

Deflation

- decrease in the general level of prices for goods and services

Business fluctuations

- irregular increases and decreases in real GDP

The Output-Expenditure Model

- macroeconomic model describing aggregate demand by the consumer, investment, government, and foreign sectors - Written as: GDP=C+I+G+(X-M) - Equation is used to explain and analyze the economy's performance - Foreign sector's purchases are called net exports of goods and services: net expenditures by the foreign sector; equal to total exports less total imports

Business cycles

- regular increases and decreases in real GDP - can interrupt economic growth

Pricate Ownership

- the Fed is privately owned by its member banks - Member banks: a commercial bank that is a member of, holds shares of stock in, the Fed. - National banks - those chartered by the national government - must belong to the Fed. - State banks - those receiving their charters from state governments - have the choice to belong or not

Phases of the Business Cycle

- the first phase is recession: decline in real GDP lasting at least two quarters (6 months) - Begins when the economy reaches a peak - Ends when the economy reaches a trough (point in time when real GDP stops declining and begins to expand) - the second phase is expansion: a period of uninterrupted growth of real GDP)

Disposable Personal Income

- the total income the consumer sector has at its disposal after personal income taxes - At the individual level, a person's disposable income is equal to the amount of money received from an employer after taxes and Social Security have been taken out

Personal Income

- total amount of income going to the consumer sector before individual income taxes are paid - Does not include payments into the Social Security fund that working people make - Include Social Security checks that retired individuals receive

Base year

- year serving as point of comparison for other years in a price index or other statistical measure -

Keynesian Economics

-a belief that it is the federal government's responsibility to stabilize the economy - Even if the government engages in deficit spending

District Banks

- 12 Federal Reserve district banks and their branches are strategically located to be near the institutions they serve - Provide many of the same function for banks and depository institutions that banks provide for us - Accept deposits form, and make loans to, privately owned banks and thrift institutions

Monetary Policy

- Actions by the Federal Reserve System to expand or contract the money supply in order to affect the cost and availability of credit - Influences economic activity - Based on the mechanism on supply and demand - Shows the demand curve for money has usual shape but supply curve doesn't have it's usual shape because money is fixed at any given time - Easy money policy - Tight money policy

Nominal vs. Real GDP

- Base year: year serving as point of comparison for other years in a price index or other statistical measure - Real GDP: gross domestic product after adjustments for inflation - Measured with a set of constant base year prices - Current or nominal GDP: gross domestic product measured in current prices, unadjusted for inflation - The output for any given year was measured using the prices that existed in those years - Real grows more slowly than current because current reflects the distortions of inflation

Two Principles of Taxation

- Benefit Principle: Belief that taxes should be paid according to benefits received regardless of income. Good example is gasoline taxes. Limitations are those who receive government services may be the ones who can least afford to pay for them and two benefits are often hard to measure - Ability-to-Pay Principle: Belief that taxes should be paid according to level of income regardless of benefits received. Example is individual income tax. Based on the fact that we can't always measure the amount of benefits derived from government spending and two it assumes that people with higher incomes suffer less discomfort paying taxes than people with lower incomes

Productivity and Growth

- Can affect productivity and growth by changing the incentives to save, invest, and work - Why work if taxes are high?

Behavior adjustment

- Can be used to encourage or discourage certain types of activities - Sin tax: relatively high tax designed to raise revenue and discourage consumption of a socially undesirable product such as alcohol and cigarettes

CPI

- Consumer Price Index - Series used to measure price changes for a representative sample of frequently used consumer items - Tracks monthly changes in the prices paid bu urban consumers

Economic sectors

- Consumer Sector - Investment Sector - Government Sector - Foreign Sector

Causes of Inflation

- Demand-pull inflation: Explanation that prices rise because all sectors of the economy try to buy more goods and services than the economy can produce - Cost-push Inflation: Explanation that rising input costs, especially energy and organized labor, drive up the prices of products - Wage-price spiral: Higher prices cause workers to ask for higher wages and cycle begins - Excessive monetary growth: Occurs when the money supply grows faster than real GDP. Extra money increases people's purchasing power which causes a demand-pull effect

Criteria for Effective Taxes

- Equity: should be impartial and just. Want to avoid tax loophole (exceptions of oversight in the lax law allowing a taxpayer to avoid paying certain taxes) - Simplicity: Should be understood by everyone. People dislike individual income tax because it is a code that is thousand pages long. Sales tax is simpler - Efficiency: Easy to administer and successful at generating revenue. Good example is individual tax income. Bad example is toll booths

Maintaining the Money Supply

- Fed Responsibility - Money is distributed to the Fed's district banks for storage until it is needed by the public - Fed is also in charge of destroying money

Reserve Requirement

- Fed can change this requirement for all checking, time, and savings accounts - Contractions: decrease requirements - Expansion: increase requirement

Acting as the Government's Bank

- Fed responsibility

Regulating and Supervising Banks

- Fed responsibility - Establishes specific guidelines that govern banking behavior - Monitors, inspects, and examines various banking agencies to verify that they comply with existing banking laws

Maintaining the Payments System

- Fed responsibility - Fed works with agency to ensure that covers the electronic transfer of funds between businesses, state and local governments, finical institutions, and foreign central banks operates smoothly

Preparing Consumer Legislation

- Fed responsibility - Has authority to extend truth-in-leading disclosures to millions of individuals who borrow from retail stores, automobile dealers, banks, and leading institutions

Incidence of a Tax

- Final burden of the tax - Much easier for the producer to shift the incidence of a tax to the consumer if the consumer's demand curve is relatively inelastic

Sources of Unemployment

- Frictional Unemployment - Structural Unemployment - technological Unemployment - cyclical Unemployment Seasonal Unemployment

Cost of Instability

- GDP gap: Difference between what the economy can and does produce. A measure of output not produced because of unemployment resources - Misery Index or discomfort index: unofficial statistic that is the sum of the monthly inflation and unemployment rates. Reasonable measurement of consumer suffering during periods of high inflation and high unemployment - Uncertainty: If workers are worried about money they won't buy as much so unemployment increases - Political instability: Voters vote people out of office and are willing to vote for radical change - Crime, Poverty, and Family Instability

Net National Product

- GNP less depreciation charges for wear and tear on capital equipment - Represents the capital equipment that wore out or became obsolete during the year

GNP

- Gross National product - total dollar value of all final goods, services, and structures produced in one year with labor and property supplied by a country's residents, regardless of where the production takes place - Add the payments that Americans receive form outside the US, then subtract the payments made to all foreign-owned businesses located in the US - The most comprehensive measure of our nation's income

GDP

- Gross domestic product - the dollar value of all final goods, services, and structures produced within a country's national borders during a one year period - Ex: Japanese products produced in Ohio count - Multiply all of the final goods and services produced in a 12-month period by their prices, and then add them up

Foreign Sector

- Includes all consumers and producers outside the US - Does not have a specific source of income - Represents the difference between the dollar value of goods sent abroad and that of goods purchased from abroad, identified as (X-M)

Three major tools the fed can use to conduct monetary policy

- Reserve Requirement - Open Market Operations -

Federal Government Revenue Source

- Individual Income taxes: Collected with a payroll withholding system. Uses indexing (keeps workers from paying more in taxes just because of inflation) - FICA Taxes: tax levied on employers and employees to support Social Security and Medicare. called payroll taxes - Borrowing: Borrows by selling bonds to investors. has become dependent on borrowing. - Corporate Income Taxes: tax on corporate profits. Taxed separate from individuals because the corporation is recognized as a separate legal entity - Excise Taxes: general revenue tax levied on the manufacture or sale of selected items. Example is telephone services and tires. tend to be regressive - Estate and Gift Taxes: estate tax is tax on the transfer of property when a person dies. Gift tax is tax paid by the donor on transfer or money or wealth

Hyperinflation

- Inflation in excess of 500 percent per year

Economic Impact of Taxes

- Influence the economy by affecting resources allocation, consumer behavior, and the nation's productivity and growth - Burden of taxes doesn't always fall on the party being taxed

Discount Rate

- Interest rate that the Federal Reserve System charges on loans to the nation's financial institutions - Third major tool of monetary policy - Only finical institutions can borrow from the Fed - Contractions: decrease requirements - Expansion: increase requirement

Excluded from GDP

- Intermediate products: products that are components of other final products included in GDP - Ex: tires on a new car - Secondhand sales: sales of used goods not included in GDP - Nonmarket transaction: economic activity not taking place in the market and, therefore, not included in GDP - Ex: when you mow your own lawn - Underground economy: unreported legal and illegal activities that do not show up in GDP statistics - Ex: drugs

Supply-Side Policies

- Key goal is reducing government's role in the economy by reducing the number of federal agencies, spend less at the federal level, and deregulation - DeregulationL relaxation or removal of government regulations on business activities - Designed to promote economic policies are designed to promote economic

Consumer Sector

- Largest sector - Basic unit is the household - Household: basic unit of consumer sector consisting of all persons who occupy a house, apartment, m or separate living quarters - Unrelated individual: person living alone even though that person may have relatives living elsewhere - Household include unrelated individual and family

Investment Sector

- Made up of proprietorships, partnerships, and corporations that are responsible for producing the nation's output - Income comes from the retained earnings (the profits not paid out to owners) that are subtracted from NI and the depreciation of capital consumption allowances that are subtracted from GNP

Fed Responsibilities

- Maintaining the Money Supply - Maintaining the Payments System - Regulating and Supervising Banks - Preparing Consumer Legislation - Acting as the Government's Bank

Federal Open Market Committee

- Makes decisions about the level of interest rates - 12 voting members - Meets 8 times a year to review economy and to evaluate factors such as trends in construction, wages, prices, employment, production, and consumer spending - Decisions have a direct impact on the cost and availability of credit - IS the Fed's primary monetary policy-making body

Tight money policy

- Monetary policy that results in higher interest rates and restricted access to credit - Slows economic growth because higher interest rates normally encourage everyone to borrow and spend less

Easy money policy

- Monetary policy that results in lower interest rates and greater access to credit - Stimulates the economy because people borrow more at lower interest rates

Supply-Side Economics

- Often supported by conservatives - Cut business taxes and taxes for the wealthy to stimulate overall supply which will lead to greater employment thus stimulating demand (trickle down economics theory) - Laffer curve

Demand-Side Economics

- Often supported by liberals - Cut individual income taxes to stimulate overall demand - Proponents of increasing government spending

Macroeconomics

- Part of economics that deals with the economy as a whole and uses aggregate measures of output, income, prices, and employment - GDP is a macro measure

Unemployment rate

- Percentage of people in the civilian labor force who as classified as unemployed - Calculated by dividing number or unemployed people by civilian labor force - Sent to everyone monthly - Doesn't count those too frustrated or discouraged to look for work - People are considered employed even when they only hold part-time jobs

Stagflation

- Period of slow economic growth coupled with inflation

Structure of the Fed

- Private Ownership - Board of Governors - District Banks - Federal open Market Committee - Advisory Committee

Three Types of Taxes

- Proportional Tax: Tax in which the percentage of income paid in tax is the same regardless of the level of income. Example: Medicare is 1.45 percent of everyones income. - Progressive tax: tax in which the percentage of income paid in tax rises as the level of income rises. uses Marginal tax rate (tax rate that applies to the next dollar of taxable income) - Regressive Tax: tax in which the percentage of income paid in tax goes down as income rises. Example is taxes on food and clothes

Consequences of Inflation

- Reduced Purchasing Power: Dollar buys less as prices rise so people on a fixed income suffer - Distorted spending patterns - Encouraged speculation: Inflation tempts some people to speculate heavily in an attempt to take advantage of rising prices - Distorted distribution of income: During long inflationary periods, creditors are hurt more than debtors because earlier loans are repaid with dollars that buy less

Creeping Inflation

- Relatively low rate of inflation, usually 1-3 percent annually

Market Basket

- Representative selection of goods and services used to compile a price index - Uses the prices of approximately 364 goods and services which are selected to represent the types of purchases that most consumers make - To find price index take average price of each item in market basket then add them all up