Government and the Economy

Prior to 1930s

• Little government involvement in improving economic performance
• Market outcomes prevailed

Great Depression

• High unemployment: as much as 25%
• Substantial reduction in living standards

Causes

• Stock speculation bid up stock prices
• Increases in tariffs--caused a reduction in international trade
• Actions of Federal Reserve System--cut the money supply

Government roles since 1930s

• Provide jobs--keep unemployment low
• Maintain stable prices--avoid inflation
• Promote growth in the economy

Unemployment

• Types
  • Frictional--people who are between jobs
  • Structural--people who lose their job because of changes in consumer prefernces or technology
  • Cyclical--people who lose their job because businesses are cutting back on production
• Measurement of unemployment
  • Monthly interviews are conducted throughout the U.S.
• Criteria for being counted as unemployed
  • 16 years or older
  • Available for work
  • Made some effort to find work
• Full employment--little unemployment except frictional, usually considered to be about 5%.
• Current rate: 4.7% and increasing

Inflation

• Definition: General increase in prices
• Cause: Demand > supply
• Who is hurt?
  • Lenders who are repaid in less valuable dollars
  • People on fixed incomes who pay higher prices but have no more money
• Measurement
  • Monthly surveys of sellers are conducted throughout the U.S.
  • Inflation rate determined by computing the cost of a market basked of goods--simple example below:

  • 	100 Galon Gas	10 Lbs. Steak	Total Cost
    Year 1	$1.00	$2.00	$120
    Year 2	$1.25	$3.50	$160

  • Rate of inflation is: (160-120/120 = 33%
• Consumer Price Index (CPI) is the most common measure of inflation in the U.S.
  • Based on a market basket of about 600 goods and services
  • Current rate: 2-3% per year
• Hyperinflation: An inflation rate of > 50%/month
• Usually caused by governments printing money

Growth

• Measurement
  • Gross Domestic Product: Dollar value of final goods and services produced
• Current rate: Negative
• Important terms
  • Recession: two consecutive quarters where GDP declines
  • Depression: unemployment >10% and a significant decline in GDP
• Balancing inflation and growth: Very rapid growth in GDP may trigger inflation