1. Stabilizing the National
Economy
Chapter 17

2. UNEMPLOYMENT
AND INFLATION
Section 1

3. Learning Goals
• Identify the two problems the government
faces in measuring unemployment
• Describe the 4 kinds of unemployment.
• Explain how demand-pull inflation differs
from cost-push inflation

4. Stabilization Policies
• Unemployment leads to uncertainty
– For people on it
– For the American economy
• Stabilization policies are used to keep the
economy healthy and the future predictable for
planning, saving and investing through monetary
& fiscal policies

5. Measuring Unemployment
• Unemployment rate- the
% of the civilian labor force
that is w/out jobs but that
IS actively looking for
work.
• High unemployment =
trouble in the economy
• Maintaining low
unemployment rate is a
major goal in stabilizing the
economy

7. Types of Unemployment
Cyclical Unemployment
associated with up
or down
fluctuations in the
business cycle
Rising during
recessions and
depressions; falls
during recoveries
and booms
Structural Unemployment
caused by changes
in the economy,
such as a
technological
advances or
discoveries of
natural resources
Can result when
workers are replaced
by computers or
other machines or
when cheaper
natural resources are
found else-where;
often affects less
skilled workers

8. Seasonal Unemployment
caused by
changes in the
seasons or
weather
Affects construction
workers, particularly in
the Northeast and
Midwest; also affects
farmworkers needed
only during certain
months of the growing
season
Frictional Temporary
unemployment
between jobs because
of firings, layoffs,
voluntary searches for
new jobs, or retraining
Always exists to some
degree because of the
time needed between
jobs to find new work
and the imperfect
match between
openings and applicants

9. Full Employment vs
Unemployment
• Full employment- condition of the
economy when the unemployment rate
is lower than a certain perfecntage
established by economists’ studies
• **unemployment rate is ONLY an
estimate
• It does not include people who work in
family businesses without receiving pay
or people who are unemployed and do
not look for work

10. Unemployment Difficulties
• government staticians can’t interview ever
person in/out of the labor force
• Underground economy- transactions by
people who do not follow federal and state
law with respect to reporting earnings

12. Review
• Q:What are two problems the government
faces in measuring unemployment?
• A: Staticians can’t interview every person in
and out of the labor force; existence of an
underground economy

13. Inflation
• Economy can usually adapt to gradually rising prices
[avg- 3%/yr]
• High inflation=
– Creditors raising interest rates to maintain level of profits
– Slows economic growth
– Effects standard of living-
– EX.- 5% raise during 8% inflation
– Especially bad for those on fixed incomes

16. Why Does Inflation Occur?
• Two theories:
• Demand-PullTheory [prices are pulled up by
high demand]
• Cost-PushTheory [prices are pushed up by
high production costs and wages]

17. Demand-Pull
• Prices rise as the result of
excessive business and
consumer demand;
demand increases faster
than total supply resulting
in shortages that lead to
higher prices
• if the FED causes the $ supply
to grow to rapidly [people
spend additional funds on
limited supply]
• Increases in government
spending and in business
investment
• Aggregate demand can
increase if taxes are reduced
or consumers save less

18. Assumption of Demand-Pull
• Increased demand will increase output and
reduce unemployment
• EXPERIENCE has shown that rising prices +
unemployment may occur @ the same time
• Stagflation- the combination of inflation and
low economic activity

19. NOTICE how it is rising more rapidly than the
economy’s productive capacity
ALSO- the equilibrium of the economy moves
from A to B meaning inflation due to rising prices
D0= Usual demand
D1= theAggregate
demand for goods
and services
Example: a central bank
rapidly increases the
supply of $

20. Cost-Push
• Theory that
higher wages
and profits
push up prices
• Stagflation may
be the result of
cost-push
inflation
• When businesses have to pay
higher wages, their costs increase
to maintain profits
• During cost-push period,
unemployment remains high
• Prices are adjusted due to higher
wages/profits not aggregate
demand so there is no reason to
increase output or hire new
workers

21. S1= Aggregate
Supply
S0= Actual supply
Example: Sharp rise in
price of imported oil =
rising energy prices
causing the cost of
producing and
transporting goods to
rise.
NOTICE:These higher
production costs led to a
decrease in aggregate
supply
ALSO- the equilibrium
price moves from Z toY
because of an increase
in the overall price level

23. Applying Concepts:
• Inflation & Deflation:
– Name some factors that could cause the price
of each of the following to go up or down:
– Oil
– Medical CARE
– ORANGE JUICE
– AUTOMOBILES
SHORTAGEOF OIL IMPORTS
DEMAND FOR MORE MEDICAL SERVICE
BADWEATHERCONDITIONS IN ORANGEGROVES
HIGHERAUTO PRODUCTION COSTS OR
LARGE RAISES FORAUTOWORKERS
NEW CRUDE OIL
DISCOVERIES
BETTER HEALTH
HABITS
BUMPERCROPS
BETTERTECH. FOR EFFICIENT PROD.

24. CRITICALTHINKING
• CAUSE & EFFECT- Construct a table that
identifies the causes of inflation. List 4 causes
under demand-pull inflation in column 1 & 3
causes under cost-push inflation in column 2.

25. Demand-pull Causes Cost-push causes
Rapid increase in the
money supply
High production costs
Increased government
spending & business
investment for expansion
Wage demands of large
unions
Reduction in taxes Excessive profit motive of
large corporations
Reductions in consumer
saving

26. THE FISCAL POLICY APPROACH
TO STABILIZATION
Section 2

27. Learning Goals
• Identify how income flows between
businesses and consumer
• Describe how the federal government uses
fiscal policy to combat unemployment

28. 2 Groups of Stabilization
• 1- Emphasizes the role of the Federal Reserve
• 2- the use of: fiscal policy- federal
government’s use of taxation and spending
policies to affect overall business activity

29. John Maynard Keynes
• Developed fiscal policy theories during G.D.
• Believed that the forces of aggregate s. & d.
operated too slowly in a recession- & gov’t
should step in to stimulate aggregate d.

30. Circular Flow of Income
• CFoI- economic model that pictures income as
flowing continuously b/w businesses &
consumers [remember Ch. 2?]
• Flows from businesses to households as wages,
rents, interests and profits.
• Income flows from households to businesses as
payments for consumer goods & services

31. Exceptions to every Rule
• Not all income follows this flow:
– Some are removed from the economy through
consumer saving and government taxation
• Leakage-This removal of money income
– Offsetting leakages of income are injections of income into
the economy
– Injections occur through business investment & government
spending

34. Ideally
• Leakages & Injections balance each other
• W/ this equilibrium, the income that
households save is reinjected through
business investments
• Income taken out through taxes is returned
through government spending

35. Review
• How does income flow
between businesses and
consumer?

36. Fiscal Policy & Unemployment
• The creation of job programs to reduce unemployment &
stimulate the economy
• Cuts in federal taxes used in an attempt to speed up
economic activity & fight unemployment
• Giving businesses tax credits on investments allows them
to deduct from their taxes some of the costs of new capital
equipment
– Encouraging businesses to expand production and hire more
workers

37. Fiscal Policy & Inflation
• Reduce inflation by
increasing taxes and/or
reducing government
spending
– Will reduce the aggregate
demand for goods/services
– People paying higher taxes will
have less spendable income
– What will businesses do?

38. However…
• As inflation fails, unemployment rises slightly
b/c of less business activity
• THEREFORE, fiscal policy as a means of
reducing inflation has NOT been used
frequently…

39. Review
• How can federal government use fiscal policy
to combat unemployment? [½ of the class]
• Explain how the government policy of
increasing federal, state, or local taxes could
eventually lower inflation [other ½]

40. Applying the Concept
• Keynesian economists believe the Great
Depression resulted from a serious imbalance of
leakages and injections. In the months following
the stock market crash of 1929, the desire and
ability of businesses to invest collapsed, reducing
output and causing a high rate of
unemployment. What should the government
have done?
Increased injections of government spending or cutting
taxes- giving businesses & consumers more disposable
income

41. MONETARISM ANDTHE
ECONOMY
Section 3

42. Learning Goals
• Analyze the monetarists’ theory on what the
government and the Fed should do to
stabilize the economy.
• Explain the monestarists criticisms of fiscal
policy.

43. Vocabulary
• Monetarism- theory that deals with the
relationship between the amount of money the
Fed places in circulation and the level of activity
in the economy
• Monetarists- siupporters of the theory of
monetarism, often linked with Milton Friedman

44. TheTheory
• [Chapter 15],The FED can change the growth
rate of the money supply.
• Friedman and others believe money supply
should be increased by a given % ea.Yr.
• When the amount of $ in circulation expands
too rapidly, people spend more

45. Case Studies
• If the economy is operating below capacity, this
extra demand will lead to a rise in output
• To produce more, businesses will have to hire
more workers and unemployment will decrease
• BUT if there is full employment, the increased
aggregate demand will lead to a rise in the
prices- inflation

46. Government Policy According to
Monetarists
• Friedman believed the government does more harm
than good in trying to 2nd guess businesspeople &
consumers.
• Government should not operate with budget deficits
ea.Yr. in an attempt to stimulate the economy
• Instead the gov’t should should balance the federal
budget

47. A Balanced Budget
• Would keep government from competiting with
private business to borrow money in the credit
market
• Reduce the amoung of interest the government
must pay ea.Yr.
• Monetarists oppose fiscal policy for
stimulating/slowing an economy

48. Monetarists view of the Fed
• The Fed should stop trying to smooth the
economy
• Should follow a monetary rule- monetarists’
belief that the Fed should allow the money
supply to grow at a smooth, consistent rate per
year and not use monetary policy to stimulate or
slow the economy.

49. The ideal
• According to monetarism- this would result in
a controlled expansion of the economy
without rapid inflation or high unemployment

50. MonetaristTheory and the
Federal Reserve
• Theory had a major influence on Federal
Reserve policies in the 1980s

52. Monetarists’ Criticism of Fiscal
Policy
• Fiscal policy never matches the reality for 2
reasons:
– Political process of fiscal policy- no single gov’t body
designs & implements fiscal policy
– Implementation of fiscal policy- time lags- periods
b/w the time fiscal policy is enacted and the time it
becomes effective

53. Case Study
Fiscal Policy
• President with direcor of the
Office of Management and
Budhet, the secretary of the
Treasury, and the Council of
Economic Advisers- design yet
only recommends the desired
mix of taxes & gov’t
expenditures.
Congress
• w/ the aid of many committees,
enacts fiscal policy
• Power to enact policy does not
rest with a single entity- thus
disagreements occur b/w
Congress & the President
• PLUS politicians have incentives
to take actions that will get them
reelected but may hurt the
economy in the long run

54. Time Goes by so Slowly
• Due to time lags it can take months, or years for fiscal
policy stimuli to cause employment to rise in the
economy
• Consequently, fiscal policy designed to combat a
recession might not produce results until the economy
is already experiencing inflation
• This means fiscal policy could worsen the situation

55. Review- Create a diagram to analyze what
monetarists think the government and the fed should
do to stabilize the economy.

57. Think-Pair-Share
• Describe in your own words the difference
between monetarism and monetary policy.
Share your description with a classmate until
they understand the difference.

58. Answer
• Monetarism is the theory that deals w/ the
relationship b/w the amount of $ in circulation
& economic activity; whereas monetary policy
is the action taken by the Ged to increase or
decrease the money supply.