Unit 4: MAcroeconomics
Unit 4 is covered by chapters 12, 13, 14, 15, and 16 of our textbook.
Sale of Used Goods |
Stock Transactions |
Govt. Money Transfers |
Used goods have already been counted; we count these goods when they were first produced and we don't want to double count something. We will count your new car purchase, but not when you resell it.
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Stock transactions are not counted because these are the buying and selling of futures or predictions in how we expect a company to do in the future. No good or service has been produced by buying or selling a stock.
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Every year the government sends out checks for social security, unemployment, and other entitlement programs. This money has already come from taxes from labor. We count the good or service the labor produced, not the return of your taxes in the form of entitlement benefits.
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Black Market Goods |
Transactions with No Records |
Goods sold underground or on the black market can constitute a rather large amount of money, however, these goods are illicit and are not counted when we look at GDP. Often, these have no tangible record since doing so would put the buyer or seller in legal jeopardy so there is no clear way to account for these anyway.
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Transactions that don't have records can make up a lot of our economy as well, from lemonade stands to teenage babysitters, these small jobs make communities strong and facilitate lots of movement of dollars. However, because they have no record, they are hard to track and there would be too many inconsistencies - so these do not make up part of GDP.
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To be considered unemployed, you don't just need to not have a job. You also have to be actively looking for a job and available to work. Specifically, if you are jobless, have been looking for the previous 4 weeks, and are available to work you are considered unemployed. Notice that these questions exclude the recently unemployed in the official unemployment numbers.
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This has the effect of undercounting our unemployment numbers. People who are discouraged workers and have given up, don't count against the unemployed - in fact, they don't count as part of the labor force anymore. We also have the dilemma where the underemployed aren't fully accounted for. The underemployed would find different jobs if they were able to, but are often stuck because it was the only job they could find.
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Frictional Unemployment |
Seasonal Unemployment |
The frictionally unemployed are people who have chosen to leave one job in the hope of finding another. These people are unemployed BETWEEN jobs and plan on finding another and have willfully left their jobs to find one. This is the only category that is a form of voluntary unemployment.
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Seasonally unemployment strikes hard for certain fields of work. People who work in agriculture harvesting crops will find themselves seasonally unemployed when the harvest time is over. But so will someone whose sole job is that of a mall Santa - when the holidays are over they lose their job.
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Cyclical Unemployment |
Structural Unemployment |
When we have cyclical unemployment, it is due to the business cycle. Economies go up and economies go down, and we hope to manage it, but some workers lose jobs when economies go down. These people are suffering from cyclical unemployment.
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People that are structurally unemployed are unemployed because their specific skills do not match the jobs that are available. The economy has moved on from their skillset and many jobs require new skills. This happens because of technological changes and consumer interests.
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Inflation refers to a general increase in prices. This doesn't mean that your favorite pair of shoes went up in price; instead, it means that, on average, a collection of average prices went up. The measurement is done by the CPI, or Consumer Price Index. The CPI is a measurement of prices paid for by typical urban consumers, such as food, housing, apparel, transportation, medical expenses, entertainment, education, and so on. This measurement is done by assessing urban goods since roughly 90% of the American population is urban (it makes little sense to track prices only paid for by 10% of the population since their prices will adjust proportionally anyway). Generally speaking, the inflation rate has been around 2% since 2005, and around 3% if we go back to 1914. This means that since 2005, average prices have increased by about 2% every year. The inflation rate is connected to the economy - when the economy is doing better (higher employment, leading to higher demand), we see prices rising; when the economy is doing worse (lower employment leading to lower demand), we see prices falling. But what specifically drives inflation?
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Demand Pull Theory |
Quantity Theory |
Under the theory of demand pull, prices rise because consumer demand drives prices up. If consumers believe that the economy is doing well, and they see an increase in either their willingness or ability, they will end up moving prices up. Specifically, sellers will raise prices because their is more demand to make it worthwhile for them to do so. This means that if consumers even think things will be good, they can lead to inflation due to their changing spending habits.
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With quantity theory, the idea is that there is too much money in circulation. When there is too much money, the general ability of people to buy goods has gone up, making demand go up. This is why governments don't just print more money.
For am historical case study on how this works, examine Germany's Weimar Republic. |
Cost Push Theory |
The Wage-Price Spiral |
Cost push theory states that prices are driven up by increased costs of production. When some items get more expensive or harder to produce, that will drive the price of items up. For example, if the price of oil rises, it is more expensive to ship goods and raw materials, making it more expensive for shoe makers and shoe sellers. They will have to raise prices to compensate.
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The wage-price spiral is connected to cost-push theory in that pay for laborers is a cost to production. If workers receive a pay increase, that will make it more expensive to produce an item, leading producers to want to raise prices in order to capture a similar amount of profit. However, if the price of goods is raised, workers will need another raise in order to afford the more expensive goods, leading to a spiral where both need to constantly be raised.
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People on Fixed Income |
Savers |
People on fixed income, for example people who are retired, see the same amount of income every month for the rest of their lives. They won't ever see a raise. As prices rise, it becomes harder for them to afford everything.
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If you only save money are hurt by inflation as well. If you save money in stocks, bonds, or a savings account that grows at a lower interest rate then inflation, you are actually losing value. Your money needs to grow at or beyond the rate of inflation in order to keep up.
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Lenders |
Debtors |
Those who loan out money also see a loss in value. If I loan you $20, you will pay me back in a year with $20, but that $20 cannot buy as much when you pay me back as it could when I loaned it to you. This is why many banks offer loans with an interest rate, so they can bring back the same value as they loaned out.
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People who carry debt also are hurt inflation. When you take out a loan, you have to continually pay back the value of the loan. However, you also have to deal with rising prices due to inflation, making it harder to pay back the value of that loan. You pay back a loan with money less valuable than you took out.
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There are three tax structures that can be utilized to collect taxes: progressive, proportional or flat, and regressive.
Under a progressive tax system, the tax burden (how much you can expect to be taxed) raises as you make more money, Under this system, people who make more money will pay more in taxes through a higher percentage of your income. This is the system the U.S. uses to collect income tax. This system is equitable.
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As you make more money under a progressive system you pay a higher percentage, but be wary of the different between marginal rates and effective rates. Someone who makes $510,301 or more doesn't pay 37% of that in taxes - 37% is just their highest marginal rate, the highest tax rate they fall under. This individual would pay 10% on all the money they earned up to $9,700. On their first dollar after that, they start paying 12% of their income in taxes until they have made up to $39,475. The first dollar after that, their rate turns to 22%; the first dollar after $84,200, their rate turns to 24%; and so on until they reached the 37% bracket.
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With a proportional or flat tax system, the income tax rate would be simplified so that each person, no matter their income. If it was set to 25%, for example, then the millionaire would pay 25% and the person in poverty would pay 25% - there would be no difference. While this system would hurt poorer people more, this system delivers on equality.
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In the United States, our income is taxed at a progressive rate, relying on the tax brackets above. Meanwhile, corporations and capital gains (money earned off investments) are taxed at a proportional or flat rate. Sales taxes, fees for service (like national park fees), Social Security and excise taxes, and the money paid towards tariffs are all regressive taxes. These taxes take a larger percentage of a poorer person's income to pay than a wealthier person.
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With the money the government raises, it goes towards paying for the benefits we receive as well as the budgets of various government agencies (which in turn provide us with other benefits, such as developments in science, education, subsidies, disaster relief, etc.). But most of what the government earns comes from our income taxes - that is tax taken on the money earned from labor. The next highest amount are the payroll taxes, which include the Social Security and Medicare taxes. The rest you can see in the pie chart to the left.
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The remainder of government spending is discretionary spending - it is allotted by the choice of government budget planners through Congress's budget. Most of our discretionary spending is on defense, even if the military doesn't want some of that spending. Congress keeps giving the money to build those items, however, because those items are produced by American workers so it keeps workers in a job, earning money, which helps fuel the economy. The rest of discretionary spending falls into education, scientific research, technology, national parks, infrastructure, government salaries, subsidies, disaster aid, and many other categories.
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When Congress (and remember from government, it always has to be Congress, specifically the House of Representatives) raises or lowers taxes and raises or lowers government spending, they are enacting fiscal policy. While sometimes used to ease the financial burden on Americans, it is really used to steady the economy. As we learned in the business cycle, expansions and contractions occur, and by using fiscal policy, Congress can attempt to smooth out the slopes, making it more manageable.
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Expansionary Fiscal Policy |
Contractionary Fiscal Policy |
When Congress is trying to improve the economy, they are typically fighting unemployment and poverty. They are trying to encourage economic growth. Expansionary measures are put in place to move the economy out of the trough or contraction and into expansion. Increasing spending or cutting taxes places more money into the economy. Spending directly puts money into the economy and cutting taxes leaves more money in the economy. The goal is to increase overall spending, which will lead to increased demand, increased output, and increased employment.
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If Congress needs to shrink the economy, it is because they are fighting inflation. They are trying to slow down economic growth. When they attempt to contract the economy, our economy has hit the peak and a general rise in prices is occurring. Cutting spending and increasing taxes remove dollars from the economy. By removing more dollars from the system, they decrease aggregate demand. The goal when pursuing contractionary measures is to decrease overall spending. This will lead to decreased demand, decreased output, and a decrease in employment.
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Governments create deficits when they spend more money than they bring in through taxes in one year. This can happen quite often in the United States because people generally like it when the government spends money and when their taxes are low. To make up for this shortfall in cash, our government sells bonds. Remember, a bond is a form of loan that is paid back with interest. In this case, people who purchase bonds are loaning the government money. Eventually the government will have to pay this money back - but that is a problem for the future.
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When the government runs deficits, that gets added to the national debt, paid for by selling bonds to various entities. But why would governments run deficits? Are deficits good or bad?
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In Favor of Deficits |
Against Deficits |
When regulating the economy, the Federal Reserve is either going to enact expansionary monetary policy to help improve unemployment and fight poverty or enact contractionary monetary policy to tackle the issue of inflation.
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The Federal Reserve likes to keep inflation around 2.5%, high enough that it shows the economy is improving but low enough to be manageable. In order to enact expansionary or contractionary policies, it has 3 main tools: adjusting the reserve requirements, adjusting the discount rate, or open market operations.
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Reserve RequirementsThe Federal Reserve sets a reserve requirement - the amount of money that banks have to have on hand, kept in reserve, at any given time. By adjusting the reserve requirement, they adjust what percentage of the money banks house they can loan out to do business. By lowering the reserve requirement, banks have more money to loan out and so they can do more business, putting more money into the economy and implementing expansionary monetary policy. If they raise the reserve requirement, banks have less they can loan out and they do less business, leading to contractionary monetary policy.
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Discount RateThe Federal Reserve also sets a discount rate. This is the rate at which the Fed loans out money to banks. Banks borrow money to be able to continue to do business. Banks have to set their loan interest rate higher than the discount rate to make a profit and enough to pay back their loan and interest. The discount rate, therefore, is always lower than bank interest rates. If the Fed lowers the discount rates, it is cheaper to take out loans, leading to more money in the economy and expansionary policy. If the Fed raises the discount rate, it is more expensive to take out a loan and less loans get taken out - this is contractionary policy.
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Open Market Operations - Buying BondsIf the Fed wants to implement more expansionary monetary policy, they can also buy bonds from the marketplace. By purchasing bonds, they remove the bonds from the banks and replace it with money. This puts more dollars into the accounts that banks can use to do business and make loans. With more money to do business, there is more demand, which leads to expansionary policy.
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Open Market Operations - Selling BondsWhen the Federal Reserve needs to get money out of the economy and implement contractionary monetary policy, it can buy bonds from their member banks. By purchasing the bonds, it removes dollars from the accounts of the banks, which means they have less money to do business with and less money to make loans with. This leads to less dollars in the hands of consumers and less money in the economy, leading to economic contraction.
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