© Goodheart-Willcox Co., Inc. Government and the Economy

Government and the Economy

Chapter Objectives

• Diagram and explain the four parts of the business cycle.

• Compare and contrast recession, inflation, and stagflation.

• Describe how the government uses fiscal and monetary policy to combat inflation and recession.

• Explain the economic consequences of government taxing and spending.

continued

Chapter Objectives

• Explain how the national debt hurts the economy.

• Describe the government’s role in promoting competition.

• Identify the laws and government agencies that protect consumer interests.

Economic Conditions Monitored by the

Government• The business cycle

– Contraction: period of slow or no growth

– Trough: end of a contraction– Recovery: period when business

activity begins to grow again– Peak: height of recovery

Recession and Depression

• Recession– Extended period of slow or no

economic growth– Two or more quarters of negative

growth• Depression

– Occurs when a recession lasts several years or more

– Example: The Great Depression of the 1930s

continued

Recession and Depression

• Depression is characterized by– high unemployment– decline in retail sales– lowered average personal incomes– decreases in consumer spending– reduced spending by businesses

Inflation

• Inflation threatens the nation’s prosperity

• Today’s dollars buy less than last year’s dollars

continued

Inflation

• Demand-pull inflation– Occurs when the economy is

growing– As demand goes up, prices go up

• Cost-push inflation– Triggered by price increase of a

widely used good, such as oil

Stagflation

• Stagflation is a period of slow growth and high inflation

• Best example occurred in the 1970s– Raised oil prices triggered inflation– Slow economic growth, high

unemployment

In Your Opinion

• What types of goods and services would likely cost more following increases in the price of oil?

Impact of Unemployment and Underemployment

• Full use of productive resources, including labor force, ensures prosperity and stability

• Unemployment hurts workers, families• Unemployment rate rises during

periods of slow growth and contraction• Government policies impact

unemployment

continued

Impact of Unemployment and Underemployment

• Types of unemployment– Frictional—job loss among workers

temporarily between jobs– Structural—job loss among people whose

skills are not in demand; long-term– Cyclical—job loss during economic

contraction– Seasonal—job loss among people holding

temporary seasonal jobs

Underemployment

• Underemployment occurs when– people want to work full-time but

can only find part-time work– people settle for jobs requiring

fewer skills and/or education than they possess

Factors Affecting Economic Policies

• Economic goals of government– Moderate the ups and downs of business

cycles

continued

Factors Affecting EconomicPolicies

• Other economic goals of government– Increase economic growth and

prosperity– Increase employment – Keep inflation low– Insure proper balance of trade in

world markets

Fiscal Policy

• Fiscal policy, which is determined by the U.S. Congress, can– stimulate the economy in periods

of recession and high unemployment

– slow economic activity in periods of inflation

Gross Domestic Product

• Gross domestic product (GDP) measures economic growth and includes

– consumer spending

– investments by businesses

– net exports of goods and services

– government spending

continued

Gross Domestic Product

• Real GDP is GDP adjusted for inflation– Drop in GDP indicates weakening

economy– Rise in GDP indicates economic

growth– Unexpected spurt can indicate

future inflation

Consumer Price Index

• Consumer price index (CPI)– Measures the movement of prices for

a bundle of select goods and services– Used to calculate cost-of-living

increases for• members of labor unions• those receiving Social Security and

pension benefits

Fiscal Policy During Recession and Inflation

• During recession, fiscal policy is aimed at increasing the amount of money in circulation

• Government does this by– increasing government spending – lowering taxes so people have more

money to spend

continued

Fiscal Policy During Recession and Inflation

• During inflation, fiscal policy aimed at decreasing the amount of money in circulation

• Government does this by– decreasing government spending – increasing taxes so people have

less money to spend

Monetary Policy

• Monetary policy refers to actions by the Federal Reserve Board (Fed) to change the supply of money

• Fed regulates the nation’s money supply and banking system

continued

Monetary Policy

• Federal Reserve System consists of– Federal Reserve Board, headed by

a chairperson– 12 Federal Reserve Banks across

the country– Federal Open Market Committee

Reserve Requirements

• Fed requires that banks and other financial institutions set aside a percentage of their total deposits– High reserve requirement reduces

amount of money banks have to lend– Low reserve requirement increases

amount of money banks have to lend

Discount Rate

• Fed sets the interest rate commercial banks must pay for credit– Fed tends to lower

discount rate during economic slowdown

– Fed tends to raise discount rate during periods of inflation

Open Market Operations

• Fed buys or sells Treasury securities (bonds, notes, bills)– Fed increases money supply by

buying securities (puts dollars into circulation)

– Fed decreases money supply by selling securities (takes dollars out of circulation)

Easy Versus Tight Money

• Easy monetary policy speeds up the economy because– interest rates are relatively low– more credit is available – consumers borrow and spend more,

increasing demand– businesses borrow and spend more,

creating growth and new jobs

continued

• Tight monetary policy slows down the economy because– interest rates are relatively high – less credit is available – consumers borrow and spend less,

decreasing demand– businesses borrow and spend less,

resulting in fewer jobs

continued

• Manipulating the economy is difficult– The U.S. is part of a complex global

economy with many interconnected parts

– It often takes months for policies to bring about desired changes

– Solving one problem can cause others

Taxing and Spending

continued

Taxing and Spending

• Government buys goods and services from producers/sellers; capital from consumers

• Producers/sellers and consumers/workers pay taxes and receive programs, goods, and services from government

continued

Taxing and Spending

• Tax revenues pay for – government operations– services that private citizens cannot

do– items that private citizens do not

produce

Redistribution of Income

• Government redistributes income through– progressive taxes (higher-income

citizens pay a higher rate of tax)– transfer payments (tax revenues

pay for some financial assistance and benefits to certain individuals)

Deficit Spending and the National Debt

• Deficit spending occurs when government spends more than it receives in revenues each year

• Surplus is created when government receives more than it spends

continued

Deficit Spending and the National Debt

• Excess spending and borrowing increase the national debt

• Government must pay interest on the amount owed; leaves less money to pay for other needs

• Taxpayers pay for the national debt in the form of increased taxes

• Debt threatens future economic growth

Government Regulations

• Government involvement in the economy is growing

• Government regulation affects local, state, and federal levels

• Regulations seek to– promote fair competition– ensure public well-being and safety

Fair Competition

• Perfect competition is when many buyers and sellers exist

continued

Fair Competition

• Competition among multiple sellers results in– lower prices for consumers– better service – greater innovation – most efficient allocation of

resources

continued

Fair Competition

• Monopoly is when a single seller exists; seller can control price and supply

• Oligopoly is when a few large sellers exist; sellers can control price to a lesser extent than in monopoly

continued

Fair Competition

• Lack of competition hurts consumers and the economy

• Government’s anti-trust laws – prohibit monopolies – prohibit price fixing and collusion– prohibit other unfair and deceptive

trade practices– promote competition and fair trade

The Public’s Well-Being and Safety

• Regulations require– equal

opportunity– fair labor

practices– workplace

safety

continued

The Public’s Well-Being and Safety

• Regulations also require– environmental protection– pure foods, drugs, and cosmetics– product safety– truth in advertising and labeling– truth in lending and savings

Costs of Regulation

• Regulations are costly because they– create extra work and costs for

businesses– put businesses at competitive

disadvantage with unregulated businesses

– create extra work and costs for government (and citizens through taxes)

Government Agencies Serving Consumers

• Department of Agriculture (USDA) – Food safety,

food production, nutrition education, international trade

continued

• Department of Energy (DOE)– Promotes the development of

reliable, affordable, and clean energy sources

• Department of Labor (DOL)– Enforces labor laws, advances

employment opportunities, provides labor statistics

continued

• Department of Health and Human Services (HHS) includes – Centers for Medicare & Medicaid – Office of Public Health and Science– National Institutes of Health– Centers for Disease Control and

Prevention– Food and Drug Administration

continued

• Food and Drug Administration (FDA)– Enforces food

safety; regulates drugs, tobacco products, cosmetics

continued

• Social Security Administration (SSA)– Manages retirement, survivors, and

disability insurance and supplemental security income programs

• Dept. of Housing and Urban Dev. (HUD)– Promotes fair housing, home

ownershipcontinued

• Consumer Product Safety Commission (CPSC)– Enforces safety of consumer products

• Federal Trade Commission (FTC)– Regulates advertising, promotes

competition

• Securities and Exchange Comm. (SEC)– Regulates security exchanges, protects

investors from fraud

continued

• U.S. Department of the Treasury– Collects taxes, pays nation’s bills,

regulates banks, investigates financial crimes

• Federal Communications Commission (FCC) – Regulates communications by

telephone, television, radio, cable, wire, and satellite

Central Ideas of the Chapter

• The goal of government economic policies is to create economic stability and prosperity for its citizens.

• Government enacts laws and regulations to ensure fair competition and to protect the public well-being and safety.

• Government agencies at all levels assist and protect consumers by providing information, protection, and services.

Glossary of Key Terms

• business cycle. A cycle of economic activity with periods called contraction, trough, recovery, and peak.

• collusion. When companies make illegal secret agreements, usually to engage in price fixing or to shut out smaller competitors.

• consumer price index (CPI). A measurement of changes in the prices of selected consumer goods and services.

• deficit spending. When government spends more than it collects in tax revenues and must borrow money.

• depression. An extended period of economic recession.

• Federal Reserve System. The U.S. government system that regulates the nation’s money supply and banking system. It is comprised of the Federal Reserve Board, 12 Federal Reserve Banks, and the Federal Open Market Committee.

• fiscal policy. The government’s taxing and spending decisions.

• gross domestic product (GDP). The value of all goods and services produced by a nation during a specified period.

• inflation. An overall increase in the price of goods and services.

• labor force. Composed of people, age 16 and over, who are employed or looking for and able to work.

• labor union. A group of workers who unite to negotiate with employers over issues such as pay, health care benefits, and working conditions.

• monetary policy. Government actions that change the amount of money in circulation by controlling interest rates and credit terms.

• monopoly. A market situation in which one seller produces the entire output of a given product or service.

• national debt. The total amount the government owes at a given time.

• oligopoly. A market situation in which a few large companies dominate an industry.

• perfect competition. A market structure in which competition between producers results in greater innovation, better service, lower prices, and efficient allocation of resources.

• recession. An extended period of slow or no economic growth.

• stagflation. A period of slow growth and high inflation.

• tax. A fee imposed by a government on income, products, or activities, and paid by citizens and businesses.

• underemployment. Workers who are employed only part time or who are “over qualified” for their jobs.

• unemployment rate. The percentage of the labor force that is out of work and seeking employment.

© Goodheart-Willcox Co., Inc. Government and the Economy

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