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BUS 100: Chapter 3 (Economics)
Transcript of BUS 100: Chapter 3 (Economics)
How does the government control our economy?
Evaluating Economic Performance
The 2008 economic crisis, deemed the "great recession", made the economy (and how the government responds to economic problems) a hot button issue.
is the study of the choices that people, companies and governments make in allocating resources.
Think "umbrella" or "overarching"
is the study of a country's overall economic issues (ex: employment rate, tax policies, etc.)
focuses on smaller economic units such as individual consumers, families and businesses.
Global Economic Crisis
How did it happen?
More than a decade ago, our country was enjoying a period of economic prosperity. Unfortunately, the dot.com "bubble" burst in 2000. To encourage investment, the Federal Reserve decreased interest rates to historic lows. This led to the next "bubble", real estate, which burst in 2008.
What IS a "bubble"?
An economic bubble occurs when commodities or markets become overinflated and trade at values far higher than their actual value.
This refers to the government's efforts to influence the economy through taxation and spending decisions.
In general, lower taxes can boost the economy by allowing people to keep more of their money to spend.
However, government spending (with money obtained through higher taxes) can also help the economy.
The tricky part is finding the right balance between these two approaches.
This occurs when the government's budget results in higher revenues than spending.
This occurs when the government spends more money than it brings in through revenues.
When the government incurs a budget deficit, it must borrow money to cover the shortfall. The sum of ALL money borrowed over the years and not yet repaid is known as the federal debt.
The U.S. federal debt is currently nearing $17 trillion.
This refers to the government's actions that shape the economy by influencing interest rates and the supply of money.
The total amount of money within the overall economy. The two most commonly used definitions of the money supply are:
M1: All currency (paper bills and coins), plus checking accounts and traveler's checks.
M2: All of M1 plus most savings accounts, money market accounts and certificates of deposit.
When the economy contracts (shrinks), the Fed typically increases the money supply. When prices begin to rise, the Fed attempts to reduce the money supply.
How does the Fed control the money supply?
The Federal Reserve
Known as the "Fed", this is essentially
the central bank of the U.S.
The core purpose of the Fed is to
manage U.S. monetary policy.
It is headed by a seven-member Board
of Governors led by a Chairman.
Ben Bernanke has been Chairman since 2006. He is set to retire soon.
While the government does exercise some control over the Fed, it is not a government agency.
This is the Fed's most frequently used tool.
Open market operations means that the Fed buys and sells government securities (things like treasury bonds, notes and bills).
These securities are IOUs the government issues to finance its deficit spending.
When the economy is weak, the Fed BUYS open market
securities, which puts money into circulation.
When inflation is a concern, the Fed SELLS securities,
which means fewer funds for banks.
Just as you can borrow money from your bank, your bank can borrow funds from the Fed. Just as you pay interest on that loan, your bank must pay interest on loans from the Fed.
The discount rate is the interest rate the Fed charges on its loans to banks.
When the Fed reduces this rate, banks can obtain money at a lower cost which in turn increases the money supply.
When the Fed increases this rate, banks end up making fewer loans (since individuals and businesses don't want to pay the higher rate), which decreases the money supply.
The interest rate the Fed charges banks.
Reserve Requirement Changes
Banks do not actually keep in cash all of the money that depositors have in their accounts.
The Fed requires all of its member banks hold a certain percentage of funds called "reserves" (ex: 10%)
These reserves are meant to protect depositors who may want to withdraw their money without notice.
To increase the money supply, the Fed will lower this requirement so banks have money money to lend.
To decrease it, the Fed will increase the reserve % so
banks have less money to lend.
The percentage of cash banks must keep on hand.
Other Fed Functions
In addition to controlling the money supply through open market operations, discount rate and reserve requirements, the Fed has some other functions as well:
Regulating financial institutions
Providing banking services for the government and banks
Overseeing bank mergers and acquisitions
Coordinating the check-clearing process
The Free Market System
An economic system is a structure for allocating limited resources.
This includes systems such as capitalism, socialism and communism.
The economic system of the U.S. is capitalism.
Capitalism is also known as a "private enterprise system" or a "free market system".
It originated with Adam Smith, a 1700s economist, and is based on private ownership, economic freedom and fair competition.
In a capitalist economy, individuals, businesses and organizations (not the government) privately own the vast majority of enterprises.
Adam Smith is known as the "father" of capitalism.
Fundamental Rights of Capitalism
These freedoms are essential for capitalism to succeed.
The right to own a business and keep after-tax profits.
The right to private property.
The right to free choice.
The right to fair competition.
Competition is essential for capitalism to work, but not all competition works the same.
A market structure with many competitors selling virtually identical products.
Most agricultural commodities operate in this market because there are little or no differences between products.
Because of the identical nature of products, they are price sensitive. If one producer sells corn at 25 cents more than a competitor, consumers will buy from the competition since corn is basically the same.
A market structure with many competitors selling differentiated products.
Producers have some control over their pricing, depending on the value they offer their customers.
Most businesses operate under this competitive market structure.
Examples include clothing, electronics, bottled water, and a great many other industries (remember: it's the most common!)
A market structure with only a handful of competitors selling products that are either similar or different.
Examples include gas stations, soft drink industry, and the cell phone industry.
Oligopolies typically avoid intense price competition since a price war might result, which could devastate the entire industry.
A market structure with just a single producer completely dominating the industry, leaving no room for any significant competitors.
Monopolies are bad for consumers, leaving them with no alternatives, which can lead to price inflation.
Because monopolies can harm consumers, and the economy, they are illegal, with few exceptions:
A natural monopoly is legal and occurs when it is too inefficient for each competitor to build its own infrastructure (like a cable company).
Here are four
Supply and Demand
In a free market system, the interplay between buyers and
sellers determines the selection of products and prices available.
This refers to the quantity of products that producers are willing to offer for sale at different market prices.
Since businesses seek to make a profit, they are likely to produce more of a product that commands a higher market price.
This represents the relationship between price and quantity from a supplier standpoint.
As the price rises, the quantity produced by suppliers rises because businesses want to sell more products at a higher price.
This refers to the quantity of products that consumers are willing to buy are different market prices.
Since consumers seek out the lowest possible prices, they tend to buy more of products with lower prices.
This represents the relationship between price and quantity from a demand standpoint.
As the price rises, the quantity demanded by consumers decreases since, generally, consumers want to pay less for products.
The interaction between supply and demand is the equilibrium price (where the curves intersect). This is typically the ideal price.
In capitalist economies, private ownership is very important. But in planned economies, the government plays more of a role in controlling the economy. Two other economic forms, both of which are planned economies, include socialism and communism.
Socialism is an economic system based on the principle that the government should on and operate key enterprises that directly affect public welfare, such as utilities, telecommunications and healthcare.
Positives: Tax revenues fund important services like healthcare for all citizens.
Negatives: Inefficiencies and corruption can occur, higher taxes.
Socialist countries include Sweden, Germany and the United Kingdom.
Communism is an economic and political system that calls for public ownership of virtually all enterprises, under the direction of a strong central government.
Positives: Less division between the rich and the poor.
Negatives: Many communist economies have failed, lack of individual rights and choices, shortages and surpluses can develop.
Communist countries include North Korea and Cuba, but they are faltering.
It is rare to find an economic system that is strictly capitalist, socialist or communist.
Rather, most are mixed economies, with components of each.
For example, the U.S. is not a purely capitalist economy since the government owns a number of major enterprises (example: postal service, libraries, military)
How can you tell if the economy is doing well?
There are five common performance measures:
GDP measures the total value of all final goods and services produced within a nation's physical boundaries over given period of time.
All domestic production is included, even when the producer is foreign-owned (Ex: Toyota)
GDP is a vital measure of economic health, with GDP growth being an important indicator of economic progress.
The overall level of employment is another key element of economic health, because when people have jobs, they have money to spend and invest.
Most nations track this through the unemployment rate. A low unemployment rate is an indicator of good economic health.
This refers to the periodic contraction (shrinking) and expansion (growth) that occurs in the economy.
A contraction is a period of economic downturn, marked by rising unemployment.
A recession occurs in a contraction when GDP decreases for two consecutive quarters
A depression is a deep, long-lasting recession.
Recovery is a period of rising economic growth after a contraction.
An expansion is a period of high economic growth and employment.
The rate of price changes across the economy is another measure of economic well-being.
Inflation means that prices on average are rising.
Hyperinflation is when inflation spirals out of control and average prices increase more than 50% per month.
Disinflation occurs when the rate of price increases slows down.
When prices actually decrease, the economy is experiencing deflation, which is typically a sign of economic trouble.
The government uses the consumer price index (CPI) and producer price index (PPI) to measure price levels.
Productivity refers to the relationship between the goods and services that an economy produces and the resources needed to produce them.
The amount of output (goods and services) divided by the amount of input (hours worked) equals productivity.
Th gal is to be more productive by producing more goods using fewer hours.
High productivity correlates with healthy GDP growth.
Federal Deposit Insurance
The Federal Deposit Insurance Corporation (FDIC) preserves and promotes public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $250,000.
An independent agency of the federal government, the FDIC was created in 1933 in response to the thousands of bank failures that occurred in the 1920s and early 1930s.
Think that it's not possible these days for banks to fail? Think again... this video demonstrates the importance of the FDIC.