GROUP WORK , but everybody records answers
on individual sheets!
INFLATION ON COCO ISLE
Terms:
INFLATION: A rise in price level (TOOOOOO
MUCH MONEY chasing TOOOOOO FEW
GOODS!)
DEFLATION: A drop below the initial price
level
DISINFLATION: A lowering in price level which
does not drop below the original price
FOCUS: INFLATION
OBJ:
 1. Define.
 2. ID and explain appropriate contractionary policy:

A. fiscal policy

B. monetary policy
 3. Define & differentiate


A. demand-pull inflation
B. cost-push inflation
 4. Define and differentiate:
 A. disinflation
 B. hyperinflation
 C. deflation
What is INFLATION?
A rise in price level that
DECREASES the purchasing
power of money
Who does it help or hurt?
 Helps
 DEBTORS
 Borrow GOOD money and buy GOOD STUFF
 Pay back BAD money
 Hurts
 CREDITORS


Loan out GOOD money and get paid back in BAD
INFLATION eats up INTEREST and EARNINGS
 PEOPLE on FIXED INCOMES

Retirees on Social Security
2 KINDS OF INFLATION:
 COST-PUSH INFLATION: prices rise because there
is an increase in the cost of inputs (factors of
production); supply shrinks in relation to demand,
pushing EQUILIBRIUM PRICE UP!
 DEMAND-PULL INFLATION: prices rise because
there is an increase in demand (“gimmie-gimmie”);
demand increases in relation to supply PUSHING
EQUILIBRIUM PRICE UP!
Due to SUPPLY SHOCKS!
MEASURING INFLATION:
 CPI - CONSUMER PRICE INDEX:
 a tool the government uses to measure INFLATION (the
CHANGE IN PRICE of a market basket of goods and services
used by average households OVER TIME!)
 compiled monthly by the BLS – Bureau of Labor Statistics;
they pick a BASE YEAR as 100 and compare current prices to
base year prices; > 100 = INFLATION; <100=DEFLATION;
most COMMON measure (See p. 339-40)
 PPI- PRODUCER PRICE INDEX: tool that measures
inflation on the SUPPLY SIDE
 GDP DEFLATOR: a tool the government uses to measure
INFLATION; more accurate, but less common
Compiled by Bureau of Labor
Statistics
PROBLEMS & SOLUTIONS:
 PROBLEM=INFLATION; solution = SUCK money out
of the economy to slow things down (TIGHT MONEY
POLICY – CONTRACTION!)
 PROBLEM=UNEMPLOYMENT; solution = BLOW
money into the economy to stimulate growth (LOOSE
MONEY POLICY – EXPANSION!)
CONTROLLING THE MONEY SUPPLY
 FISCAL POLICY: What the
government can do (congress and
the president) – DUSTBUSTER!
 MONETARY POLICY: What the
Federal Reserve can do – BIG VAC!
(Ben Bernanke – CHAIRMAN OF
THE FED – and his gang – THE
FEDERAL RESERVE BD.)
Keynesian Economics: Fiscal Policy
and Demand Side Economics
The Employment Act of 1946
Video Tutorial
 EPISODE 26: Fiscal Policy (4:34)
 EPISODE #26: FISCAL POLICY
 PAUL SOLMAN VIDEO
FISCAL POLICY
 TAX :
raise or lower taxes
--EXPANSIONARY POLICY (BLOW! to stimulate growth)
cut taxes! LOOSE MONEY!
--CONTRACTIONARY POLICY (SUCK! to fight inflation)
raise taxes! TIGHT MONEY!
 SPEND:
increase or decrease spending
--EXPANSIONARY POLICY (BLOW! to stimulate growth)
increase spending!
--CONTRACTIONARY POLICY (SUCK! to fight inflation)
decrease spending
AUTOMATIC STABILIZERS &
DISCRETIONARY POLICY
 AUTOMATIC STABILIZERS:
 Changes in spending which DO NOT require deliberate
action from policy makers
 Kick in when needed during an economic downturn
 Example: UNEMPLOYMENT BENEFITS in a recession
 DISCRETIONARY
 Changes in spending that require the government to act


Corporate BAILOUT
New legislation on infrastructure projects like high speed rail,
to create jobs
FISCAL STIMULUS
HIGH MPC
LOW MPS
Secretary of the Treasury
Jacob “Jack” Lew
Federal Budget: (See Solman video)
 DEFICIT:
 Total amount by which EXPENDITURES exceed
REVENUES in a single year
 SURPLUS:
 Total amount by which REVENUES exceed
EXPENDITURES in a single year
 DEBT:
 Total amount of money owed by the federal
government, accumulated over the years
THE CROWDING OUT EFFECT
 EPISODE 27: Crowding Out - Lags (5:51)
 EPISODE #27: CROWDING OUT - LAGS
Video Tutorial
 EPISODE 31: The Fed (2:30)
 EPISODE #31: THE FED
 EPISODE 32: Monetary Policy (7:18)
 EPISODE #32: MONETARY POLICY

 PAUL SOLMAN VIDEO
MONETARY POLICY: The process by
which the Fed controls the money
supply
What is the Federal Reserve?
The central banking system for the
United States
Responsible for carrying on
MONETARY POLICY
Created in 1913 by the Federal
Reserve Act
12 District Banks – 25 Branches
Chairman of the Fed
WAS: Ben Bernanke
IS: Janet Yellen
MONETARY POLICY
 RESERVE REQUIREMENT (raise or lower – just NOT
done!)
 OPEN MARKET OPERATIONS (buy or sell federal
government bonds)
 INTEREST RATE (raise or lower the DISCOUNT
RATE or FEDERAL FUNDS RATE)
--DISCOUNT RATE: interest rate at which
member banks borrow from the federal reserve
--FEDERAL FUNDS RATE: interest rate at which
banks borrow from each other
TWO TYPES OF POLICIES:
 EXPANSIONARY POLICY (loose money policy) geared
to stimulate growth and create jobs
…………………...BLOW MONEY INTO THE ECONOMY!
 CONTRACTIONARY POLICY (tight money policy)
geared to slow growth and tame inflation)
……………………SUCK MONEY OUT OF THE ECONOMY!
The U.S. Economy Stagnated
in the 1970s
 President Lyndon B. Johnson’s spending on the
Vietnam War and on his Great Society program
also depleted the U.S. treasury
 Also, since the U.S. did not continue advancing,
they were caught by the Japanese and the Germans
in industries that the U.S. once dominated: steel,
automobiles, consumer electronics.
1973 OIL SHOCK
Yom Kippur War
STAGFLATION
POLITICAL POISON!
Video Tutorial
 STAGFLATION: (30:00)
CARDS UP on INFLATION
 1. A rise in the price level which
decreases the purchasing power of
money is called

a. inflation

b. deflation

c. disinflation

d. hyperinflation

e. stagflation
 2. A decline in the price level is called





a. hyperinflation
b. inflation
c. stagflation
d. disinflation
e. deflation
 3. A decline in the rate of inflation is
called

a. hyperinflation

b. disinflation

c. inflation

d. deflation

e. stagflation
 4. Modern fiscal policy results from the
work of

a. Jean Baptiste Say

b. Arthur Laffer

c. John Maynard Keynes

d. Arthur Okun

e. Thomas Malthus
 5. Which policy measure would a
Keynesian economist support to
combat recession?

a. doing nothing

b. balanced budget

c. decreasing wages

d. deficit spending

e. printing money
 6. What is an appropriate fiscal policy
measure to combat recession?

a. decreasing the federal funds rate

b. increasing government spending

c. purchasing government securities

d. increasing the reserve ratio

e. There is no appropriate fiscal
policy measure to combat recession.
 7. What is an appropriate fiscal policy
measure to combat inflation?

a. increasing government spending

b. increasing the discount rate

c. increasing the tax rate

d. increasing the federal funds rate

e. There is no appropriate fiscal
policy measure to combat inflation.
 8. What is an appropriate fiscal policy
measure to combat stagflation?

a. increasing the discount rate

b. decreasing the tax rate

c. decreasing government spending

d. purchasing government securities

e. There is no appropriate fiscal
policy measure to combat stagflation
 9. An example of discretionary fiscal
policy is

a. corporate bailouts

b. monetarism

c. Social security payments

d. open market operations

e. unemployment insurance
payments
 10. An example of automatic stabilizer
in fiscal policy is

a. open market operations

b. corporate bailouts

c. monetarism

d. unemployment insurance
payments

e. Social Security payments
 11. How many district banks make up
the Federal Reserve?

a. 5

b. 7

c. 10

d. 12

e. 14
 12. How many people serve on the
Federal Reserve Board of Governors?

a. 5

b. 12

c. 7

d. 10

e. 14
 13. Each member of the Federal Reserve
Board of Governors is appointed

a. to a 4-year term

b. for life

c. to a 14-year term

d. to a 10-year term

e. to a 6-year term
 14. The primary tool of monetary policy
is





a. open market operations
b. the discount rate
c. the reserve ratio
d. government expenditures
e. taxation
 15. The interest rate the Federal Reserve
charges for loans to banks is called the

a. consumer rate

b. discount rate

c. reserve rate

d. federal funds rate

e. prime rate
 16. The interest rate on overnight loans
between banks is called the

a. consumer rate

b. discount rate

c. federal funds rate

d. reserve rate

e. prime rate
 17. The main function of the Federal
Reserve is to

a. regulate the money supply

b. levy taxes

c. conduct fiscal policy

d. regulate wages

e. regulate international trade
 18. A monetary policy measure to
combat inflation is

a. decreasing the tax rate

b. increasing government
expenditures

c. increasing the discount rate

d. decreasing the reserve ratio

e. decreasing the prime rate
 19. A monetary policy measure to
combat recession is

a. increasing government
expenditures

b. increasing the reserve ratio

c. purchasing government securities

d. decreasing the tax rate

e. increasing the federal funds rate
 20. The current head of the Federal
Reserve is

a. Janet Yellen

b. Robert Zoellick

c. Paul Wolfowitz

d. Alan Greenspan

e. Ben Bernanke
21. A shortfall in the annual federal
budget:
 a. inflation
 b. recession
 c. deficit
 d. debt
 e. depression
22. The total amount of money owed
by the federal government,
accumulated over the years:
 a. debt
 b. deficit
 c. surplus
 d. recession
 e. trough
 23. Government borrowing for
expansionary fiscal policy increases
demand for money and interest rates, so
part of the increase in government
spending is counteracted by a decrease in
private investment.

a. the wealth effect

b. the price effect

c. the income effect

d. the crowding out effect

e. the recession effect
 24. The central banking system of the
United States:

a. the Treasury Department

b. the Commerce Department

c. FDIC

d. SEC

e. Federal Reserve
 25. The current Secretary of the Treasury is





a. Timothy Geithner
b. Ben Bernanke
c. Alan Greenspan
d. Henry Paulson
e. Larry Summers
26. A supply shock (an increase in
the cost of an input) causes:
 a. demand-pull inflation
 b. cost-push inflation
27. If you want to stimulate the economy, a tax
cut should target people with

a. a high marginal propensity to save and
a low marginal propensity to consume.

b. a high marginal propensity to
consume and a low marginal propensity to
save.
28. High inflation and high unemployment:
 a. deflation
 b. disinflation
 c. hyperinflation
 d. stagflation
 e. none of these
 29. If the CPI is 138, prices



a. have decreased 38%.
b. have increased by 38%.
c. have stayed the same.
 29. If we’re in a recession, we need a
 a. tight money policy
 b. loose money policy
 29. A contractionary policy is a
 a. tight money policy
 b. loose money policy
END OF QUIZ
WHAT IS A TAX?
 A compulsory charge or levy enacted by the
government to raise revenue to fund government
spending
 May also be used to
 Encourage behavior (TAX CREDIT/DECUDTION)
 Discourage behavior (SIN TAX)
TAX SYSTEMS:
TAX REVENUE:
Arthur Laffer: Reagan’s Econ.
Advisor
 High taxes harm the economy
by
 Stifle INVESTMENT
(drawing CAPITAL away),
thus…
 Stifle GROWTH, so…
 TAX CUTS for the RICH
 Stimulate investment, thus
 Spur GROWTH!
 Growth reduces DEFICIT


increases TAX REVENUES
Allowing gov’t to CUT
SPENDING
Laffer and Wanisky
Laffer Curve
Laffer Curve
Assume 15%
The Laffer Curve in…
THEORY
PRACTICE
 1. The
largest source of federal revenue
is the
 a. property tax
 b. personal income tax
 c. social security tax
 d. sales tax
 e. corporate income tax
 2. The two largest sources of tax revenue for
state and local governments are
 a. sales and property taxes
 b. personal income and corporate income
taxes
 c. sales and personal income taxes
 d. sales and corporate income taxes
 e. property and personal incomes taxes
 3. Personal income tax in the United States
and in the states which have it is a
 a. flat tax
 b. fair tax
 c. regressive tax
 d. liberal tax
 e. progressive tax
 4. Sales taxes are _____ because they fall
more heavily on those least able to pay.
 a. regressive tax
 b. progressive tax
 c. fair tax
 d. flat tax
 e. liberal tax
 5. Another name for proportional tax:
 a. liberal tax
 b. regressive tax
 c. fair tax
 d. flat tax
 e. progressive tax
 A tax on a specific good or service like gas:
 a. sales tax
 b. excise tax
 c. income tax
 d. property tax
 e. capital gains tax
 An excise tax which attempts to influence behavior
harmful to society as well as to raise revenue:
 a. capital gains tax
 b. value added tax
 c. regressive tax
 d. sin tax
 e. ad valorem tax
 To create the biggest stimulus, a tax cut should be
designed to benefit those with a
 a. high MPC and a low MPS
 b. low MPC and a high MPS
 c. high MPC and a high MPS
 d. low MPC and a low MPS
 A tax benefit which can be subtracted from one’s
income before figuring taxes, thus reducing the
amount of taxable income counted:
 a. a tax deduction
 b. a tax credit
 A tax benefit which is subtracted directly from your
total tax bill:
 A. a tax dedcuction
 B. a tax credit
END OF QUIZ