Ch.

14 Economic Stability

Name: Hannah Godbehere Period: 3 Date: 10/16/20

As Polly C. Phisscal planned her campaign for Congress, she realized that the health of the economy would
affect her strategy. Consequently, she checked a few economic indicators. The GDP told her the market value
of all final goods and services produced in the U.S. last year. However, it has some weaknesses because it does
not factor in money earned from trading used goods, improved product quality, etc. Polly also has to be careful
to use REAL GDP if she wanted to compare GDP over time. It takes inflation into account.
Another indicator she followed was the unemployment rate. It calculates the % of those in the labor force who
are actively seeking work. Polly realized that many people are unemployed because they are between jobs.
This is frictional unemployment. Others are out of work because of technological change. Polly’s friend
Penelope is experiencing structural unemployment. She can no longer find work in video camera repair. The
unemployment we are most worried about is cyclical. It looks at people who are unemployed because of a
recession.
In her studies, Polly discovered that the economy fluctuates. When businesses start laying off workers and
reducing investment we are in a recession. When businesses and consumers feel more optimistic about the
economy we are experiencing an expansion. The Business cycle is a diagram that is used to record these
fluctuations. It also tracks Booms and Depression.
Polly knows that the government can take effective measures to try and control the economy. Using fiscal
policy, they can regulate the economy. During a recession by cutting taxes and increasing Government
spending. they can increase economic activity. During an expansion they can control inflation by raising taxes
and decrease spending.
As a member of Congress, Polly will have little control over monetary policy, which is used by the Fed to
control the money supply. It has 3 tools to regulate the money supply: open-market operations (buying/selling
bonds) the interest rate, and the reserve requirement. During an expansion, the Fed can reduce the risk of
inflation by selling bonds, increase the interest rate, or increase the reserve the requirement. In a recession, it
can do the opposite.

increasing booms GDP selling raising inflation

cyclical depressions monetary policy decreasing
structural unemployment increasing expansion business cycle
actively seeking work frictional recession fiscal policy
taxes government spending real GDP out of work
1
Managing the economy – see green JA Textbook, Ch. 14
Economic indicators tell us where the economy is. We must know and understand this if we are going to apply
the appropriate policies. To know how healthy you are, don’t you look at your health indicators? To know how
well your favorite team is doing you look at stats or indicators. The 3 most important economic indicators are:
 1. Gross Domestic Product (GDP)
a. it measures how much the economy produces in a given time period.
- High inflation (CPI)
b. It has the following 4 components:
- Trade, consumer spending, govn. investing, business investing.
Consumer Price Index (CPI)
a. It measures inflation/deflation, price rising/shrinking.

2. Unemployment rate (UR)

a. It measures the # of people unable to find work.

b. A person between jobs is experiencing frictional unemployment.

c. A person whose job is no longer needed is experiencing structural unemployment.
d. A person who lost their job due to a recession is experiencing cyclical unemployment.
There are 2 economic policies we can use to manage the economy as needed.
1. Fiscal policy is carried out by the president & congress. It has 2 “tools” it can use:
a. Increase/decrease taxes.
b. Increase/decrease government spending
2. Monetary policy is carried out by the fed. It has 3 “tools” it can use:
a. Increase/decrease the reserve requirement.
b. Increase/decrease interest rates.
c. Buy/sell bonds
To guide us we have 3 important economic goals:
1. Full employment means unemployment rate should not exceed 4%.

a. Which economic indicator outlined above is used to monitors this goal?

2. Stable prices means inflation does not exceed 3%.

a. Which economic indicator outlined above is used to monitor this goal?

- CPI
3. Economic growth means we expect the economy to grow by about 4%.

a. Which economic indicator outlined above is used to monitors this goal?

- GDP
2
The Business Cycle shown here, displays the fluctuations in the economy.
 1. Explain each phase of the business cycle:
a. An expansion is when the economy is growing
b. A peak or boom is when the economy is growing too fast and about
c. A recession is when the economy is at rock bottom.
d. A trough or depression is when the economy is at rock bottom.

2. What is happening to the economic indicators during an expansion?

a. GDP is increasing.
b. CPI is increasing but too much.
c. UR is almost zero.

3. What is happening to the economic indicators during a peak?

a. GDP is shrinking.
b. CPI is increasing too much.
c. UR is almost 0.

4. What is happening to the economic indicators during a recession?

a. GDP is shrinking.
b. CPI is decreasing but not good news.
c. UR is increasing.

5. What is happening to the economic indicators during a trough?

a. GDP is shrinking at a high rate.
b. CPI is decreasing at a high rate.
c. UR is crashing. During great depression it reached 2%.

6. What does the diagonal line represent?

3
Applying Monetary & Fiscal Policies
The President & Congress The Federal Reserve Board (The Fed)
Fiscal Policy Monetary Policy
 Open-
Economic Government Market Interest Reserve
Condition Taxes Spending Operations Rate Requirement
1. Full employment
and rising inflation Increase Increase Buy bonds Increase Increase
Decrease Decrease Sell bonds Decrease Decrease
2. Unemployment
and declining Increase Increase Buy bonds Increase Increase
production Decrease Decrease Sell bonds Decrease Decrease
1. Assume we are experiencing economic condition 1. in the table above.
a. What phase of the business cycle are we in?
- Expansion approaching boom
b. What is the problem with GDP, CPI, and or UR?
- High inflation (cpi)
c. What fiscal policies do you propose to solve the problems?
- Increase taxes, decrease govn. funding
d. What monetary policies do you propose to solve the problem?
- Sell bonds, raise interest rate, and raise reserve reservation.
2. Assume we are experiencing economic condition 2. in the table above.
a. What phase of the business cycle are we in?
- GDP is negative, UR is too high
b. What is the problem with GDP, CPI, and or UR?
- Recession w/ danger of recession
c. What fiscal policies do you propose to solve the problems?
- Decrease taxes and increase govn. funding
d. What monetary policies do you propose to solve the problem?
- Buy bonds, lower interest rates, lower reserve requirement

In year X, the U.S. economy was showing signs of recovering from a recession. Unemployment rates were
going down, car sales and home construction was increasing. Yet there were causes for concern. The National
Debt was getting too big, interest rates were rising, and stock prices were unsteady. Volatile political situations
around the world were worrisome. It appeared that the economy was already “overheated” with inflation on the
rise.
3. Assume we are experiencing the economic conditions expressed in the story above?
a. What phase of the business cycle are we in?
- Expansion, approaching boom.
b. What is the problem with GDP, CPI, and or UR?
- High inflation (cpi).

c. What fiscal policies do you propose to solve the problems?

- Increase taxes, decrease govn. spending.
d. What monetary policies do you propose to solve the problem?
- Sell bonds, raise interest rates, raise reserve requirement.

4
The Phillips Curve
The Phillips curve is named after its creator, A.W. Phillips. He showed that when policies used to control
inflation are adopted, they usually make the unemployment rate worse. Alternatively, when policies used to
improve the unemployment rate are adopted, they usually make the rate of inflation worse. Obviously, this
outcome, made managing the economy more difficult than ever.
1. What is the trade-off described in a Phillips Curve?
- Unemployment v. inflation.
2. Assume, using the graph above, the government wants to bring the rate of inflation down from 7% to
3%,
a. What effect will this have on the unemployment rate?
- Increase about 5%.
b. What fiscal policies might the president and congress use to achieve this goal?
- Increase taxes & govn. spending.
c. What monetary policies might The Fed use to achieve this goal?
- Sell bonds, raise interest rates, and increase reserve.

3. Assume, using the graph above, the government wants to bring the unemployment rate down from 8%
to 4%.
a. What effect will this have on the inflation rate?
- It’ll increase about 4%.
b. What fiscal policies might the president and congress use to achieve this goal?
- Lower taxes & increase govn. spending.

c. What monetary policies might The Fed use to achieve this goal?
- Buy bonds, lower interest rates & lower reserve requirement.

5
The Discomfort Index
A more simplified way of looking at the relationship between inflation and unemployment is known as the
Discomfort Index. It is the sum of the rate of inflation and the unemployment rate. Politicians sometimes use
this as a measure to highlight what is happening in the economy, good or bad. The table below summarizes the
history of the Discomfort Index over 30 hypothetical years.
 Unemployment Inflation Discomfort
Year Rate Rate Index
5 8.5% 6.9% 15.4%
10 7.1% 12.5% 19.6%
15 7.2% 3.8% 11.0%
20 5.5% 6.1% 11.6%
25 5.6% 2.5% 8.1%
30 4.5% 1.6% 6.1%

1. Why is the sum of unemployment and inflation rates called a discomfort or misery index?
- B/c it’s not pleasant to experience unemployment or inflation.
2. Which is the “worst” year? Explain using the data in the table.
- 10 b/c 19.6% of discomfort index

3. Which is the “best” year? Explain using the data in the table.
- 30 b/c 6.1% of discomfort index.

4. If today, the inflation rate is 3.3% and the unemployment rate is 3.5%, what is the Discomfort Index?
- 6.8%.

5. Why might politicians refer to the Discomfort Index more frequently than the Phillips?
- It’s easier to understand for the average person.

6. Which is more useful when developing fiscal and monetary polices to manage the economy, the
Discomfort Index or the Phillips? Explain.
- The Phillips curve b/c it’s more scientific & data driven.

6
The Multiplier
To complicate matters further when implementing policies to manage the economy, it is important to consider
what is known as the multiplier. In a simple way, think what happens to a still lake if you throw a pebble across
it? Don’t ripples occur? Thus, when the government inserts or decreases the money supply there will be a ripple
effect throughout the economy. For example, if interest rates are lowered, more people will build houses, then
all sorts of construction jobs will emerge. What will the construction workers do with their paychecks? The
opposite will occur if the interest rate is increased.
Furthermore, the marginal propensity to save (MPS) and the marginal propensity to consume (MPC) are
factored in by policymakers when they are managing the economy. If money is injected into the economy, you
need to project how much of it will be saved (MPS) or how much of it will be spent (MPC). Otherwise, the
money supply is being increased by too much or not enough. We know now that not nearly enough money was
injected into the economy during the Great Depression.
Policymakers are able to calculate a number for the multiplier. They can estimate how much an increase in the
money supply can grown into as the multiplier (ripple effect) “kicks in”. For example, if $4 million is injected
into the economy during a recession and the multiplier is 5, then a total of $20 million will be generated.
1. What is the multiplier effect?
- The ripple effect of govn. policies on the economy.

2. How does the marginal propensity to save (MPS) affect the multiplier?
- It weakens the power of the ripple effect b/c money isn’t going into the economy.

3. Assume an MPS of 33 1/3% and that the money supply is increased by $3 billion. What would be the
total amount of money generated in the economy after the multiplier takes effect?
- 9 billion.

4. During an economic contraction, a U.S. president advised the nation’s consumers to buy a car, take a
vacation, or buy a house. What was the president hoping would happen? Explain.
- Consumers will spend $ so the ripple effect kicks in.
5. Explain the following statement: “the multiplier enhances the government’s monetary and fiscal
policies”.
- The multiplier makes govn. policies stronger b/c the ripple effect happens.
7
The President of the U.S. has called a meeting with various special interest groups, to discuss the state of the U.
S. economy and what can be done to improve matters. These groups will recommend monetary and fiscal
policies. However, their suggestions will be based mainly on their own viewpoint. The following groups were
represented at the meeting: corporate CEOs, AARP, NAACP, governors/mayors, military, and
environmentalists. Economic Indicators discussed were:
a. U.S. GDP has been growing at about 4% annually.
b. U.S. unemployment has been declining, now at about 5.5% nationally.
c. CPI in U.S. has remained relatively low at 3.5%, but is increasing due to high gas prices.
d. 34.5 million (12.7% ) Americans are living below the poverty level.
e. U.S. National Debt is very high, $26 trillion.
f. Expenditures on Medicare/Social Security are more than ½ of the federal budget.
g. Volatile political situations around the world are prevalent.

1. Which special interest group are you going to represent and why?
- Probably governors/majors so I could actually try and help make it a better place.

2. Based on your interest group, which of the 7 indicators are favorable to you and why?

-B. ‘U.S. unemployment has been declining, now at about 5.5% nationally.’
Because it seems like the better options of most of the choices and is actually good for the
economy.
3. Based on your interest group, which of the 7 indicators do you dislike and why?
I dislike D. 34.5 million (12.7%) Americans are living below the poverty level. Because poverty is
already barely any money people are surviving on so the fact that 34.5 million people are living
BELOW that baffles and saddens me.

4. Which fiscal policies do you want to see implemented? Explain how might they benefit your group?

- I would like to see a decrease in taxes and an increase in govn. funding because lower taxes
should help the people keep more money throughout the year but the only downside is they
wouldn’t really get their taxes back.

5. Which monetary policies do you want to see implemented? Explain how might they benefit your group?
- I’d like to see monetary policies like buying bonds and lowering interest rates to try and
positively change the situation.