Achieving Economic
Stability
The Cost of Economic Instability
• Forms of Economic instability
– recession
– High unemployment
– Inflation
• Stagflation: a period of stagnant growth
combined with inflation
– Experienced in 1970’s
The Cost of Economic Instability
• Economics Cost
– GDP gap: measures
the differences
between the actual
GDP and the GDP that
could have been
achieved had all the
resources been fully
employed
The Cost of Economic Instability
• The misery index: the sum of monthly inflation
and unemployment rates
• Uncertainty increases when GDP decreases
Social Cost
• Economic Instability
– Results in wasted labor, capital, and natural
resources
– Can lead to political instability
– Associated with:
• Increased crime
• Lower levels of police protection
• Less willingness by companies to hire
disadvantaged people
Macroeconomic Equilibrium
Aggregate Supply
Total value of goods and services that
all firms would produce in a specific
period of time at various price level
Aggregate Supply Curve
• Shows the amount of
real GDP that could
be produced at
various price levels
Aggregate Supply Curve
• Cost fall = ASC shifts
to the right
• Cost Rise = ASC
shifts to the left
Aggregate Demand
Total quantity of goods and
services demanded at different
price levels
Aggregate Demand Curve
• Quantity of real GDP
that would be
purchased at various
price levels
Figure 16.4a
Aggregate Demand Curve
• shifts curve to the
right
– Decrease in savings,
– expectations of strong
economy,
– increase in transfer
payments financed
through deficit
spending,
– reduction in taxes
shifts curve to the right
Figure 16.4b
Aggregate Demand Curve
• Shifts curve to the left
– Increase in savings
– Expectations of a
weak economy
– A decrease in transfer
payments through
deficit spending
– An increase in taxes
Figure 16.4b
Macroeconomic Equilibrium
Level of real GDP consistent with a
given price level, as determined by the
intersection of the aggregate supply
and aggregate demand curves
Macroeconomic Equilibrium
• Achieved when
aggregate supply
equals aggregate
demand
• Does not provide
exact predictions
about the economy
• Useful for analyzing
macroeconomic
trends
Stabilization Policies
Demand-Side Policies
• Federal Policies designed to increase or
decrease total demand in the economy by
shifting the aggregate demand curve to
the right or left
• Fiscal Policy: the federal governments
attempt to stabilize the economy through
taxing and government spending
Demand-Side Policies
• John Maynard Keynes (1883-1946) was one of
the most influential economists of the twentieth
century. In addition to revolutionizing economic
thinking about fiscal policy, he played a central
role in the Bretton Woods Conference of 1944,
which created the International Monetary Fund
and the World Bank.
• Keynesian Economics: a set of actions designed
to lower unemployment by stimulating aggregate
demand
•
Demand-Side Policies
• Multiplier Effect: a change in investment
spending will have a magnified effect on
total spending
• Accelerator effect: change in investment
is caused by a change in overall spending,
a downward economic spiral
• According to Keynes: only the
government is large enough to offset
changes in investment spending
Demand-Side Policies
• Automatic stabilizers = unemployment
insurance and federal
– Increase government spending whenever
changes in the economy threaten people’s
income
• Long Run:
– All attempts by gov’t to increase aggregate
demand merely increase the price level
without increasing GDP
Supply Side Policies
• Reducing Taxes = increase in tax
collections failed to materialize in
the1980’s
• Successful policies can shift aggregate
supply
– Moving economy into equilibrium
• Seek to promote economic growth rather
than economic stability
Laffer curve
Monetary Policies
• Believe the money supply should be
allowed to grow
– Slow and steady
– Trying to control inflation
– Permit economic growth
• Expanding the money supply cannot
permanently affect rate of employment
Economics and Politics
Changing Nature of Economic
Policy
• Discretionary fiscal policy
– Used less today
– Has increased the use of monetary policy
• Passive Fiscal Policy
– Contribute to stability of the American Economy
• Structural Fiscal Policy
– Designed to strengthen the economy in the long run
– Does not deal with unemployment or inflation
Why Economist Differ?
• Choose polices that reflect their sense of
which economic problems are most critical
• Affected by the economic conditions
prevailing in their lifetimes
Economic Politics
• The Council for Economic Advisors
– Advises the president of the United States on
economic policy
• Contribute to the understanding of economic
activity
• Help policy makers prevent another Great
Depression, stimulate growth, help
disadvantaged groups
• Cannot help a country AVOID minor recessions