1.
ESSAY (200-300 words): What is inflation, and how does it affect consumers? Is inflation always bad? Describe a situation where inflation is positive?
No Wiki or Dictionary.com
. theory about how the econ-
orny works. At one tirne, for
examPle, a nation’s eco-
nomic vitalitY was thought
to sPring from the stock of
precious metals accumu-
lated in the Public treasury’
This theory spawned a
”’ po1iry called mercantiiism’
‘ which held that, as a waY of
accumulating gold and sil-
ver, a nation should try to
ir {” export more than it imPorts’
To achieve this, nations
duce a major tax increase
of the economy, just as we need not know
every
i”,”ii of the uoay. rut we must understand essen-
dal relationships among key variabies’
For example’
does the economy *otf *”U on its own’ or does it
;;;;m poorly? If it performs poorly’ are there
i**”di”tl can we u” ttt” that a proposed remedy
*””iJ “”,
do more harm than good? When doctors
;idtt’; understand how the human body
worked’
,h”1,
“,,u*pted
“cures” were often worse than the
Ji*r”r. Much of the history of medicine describes
misguided efforts to deal with maladies’
Even today’
medical care is based on less
mercanr*ism ffiiliTr:Ji1″[:””i?&t1:
the inrortecttheorythat onJ study, only one in seven
a nation’s economic
urrt -!usJ t -‘*t -,-. ,
li;u.*iu”.t’ould be to medical interventions is sup-
J””u*utut” precious ported by reliable scientific
metals in the public lviaence.r For example, acet-
treasqrY; this theorY
prompted trade bar’ aminophen (e’g’, Tflenol) is
riers io
“ut
itnports, a popular pain reiiever, but
ffilljl’?#n t’oto^aY ruallY knows how it
trade and the gains {rorn works’
srecialization LikewiSe, policy makers
economic maY adoPt the wrong Pre-
{|::HlT;?i, .,, -“”, scription
-b””””‘”
or a flawed
nomie activitY relative
to the [ong’term growth t. As reported by Shenrvin Nuland,
fi:i:il:i::?JJJ” ;r,rr’iicjlua’,dran,Midwivesand
;;;J’
— —
Leech es:’ NewYork llmes’ 25 January
1 S95.
during the Great Depression’ Economists
have srnce
[-*,.’a that such a policy does-more harm than
;;.; “Jai
iott, debates about whether policies
are
i”fnf”f or harmful were prevalent as poiicy makers
t”tio”a*a to the zoo8-2oo9 economic downturn’
We turn now to the performance of the U’S’
economy.
Wz Hconomic Fluctuations
and Growth
The U.S. economy and other indush’ial
rnarket
u.orro*i”” historlcally have experienced alter-
;;;;; Fiods of expansion and contraction
in u.loo*ic activity’ Economic fluctuations are
ti,”rir”andfaliofeconomicactivityrelativetothe
torrg-,ur* growth trend of the economy’
These fluc-
arr”iionr, oibusiness cycles, vary in length
and inten-
cirv- vet some featurua “ppu”t
common to all’ Th*
;;i il il*”t”*”*ilv invot”e the entire nation ani
often many other eco-nomies around
the world’ and
;;;;;;”early all dimensions of economic activ’
ity, not just production and employment’
U.S, Economic Fluctuations
Perhaps the easiest way to understand
the busine:s
.y.i” it ,” *amine its components’ During
the r9z+*
70 PART z Fundamentals ol lrnacroeconcmtcs
Expansion
.::C r93os, WesleY C. Mitchell,
:trector of the National Bureau
:i Economic Research (NBER)’
;talyzed business cYcles, not-
,rg that the economY has two
:hases: expansions and contrac-
::cns. During an exPansion, the
economy’s outPut increases.
During a contraction, the econ-
cmy’s outPut decreases’ Prior
io World War Ii, a contraction
might be so severe as to be
calied a depression, which is a
sirarp reduction in the nation’s
total production lasting more
than a year and accomPanied bY
high unemPloYment. A milder
contraction is called a reces-
sion, traditionallY defined as a
decline in total outPut lasting
at ieast two consecutive quar-
ters, or at least six months’ The
U.S. economY exPerienced both
recessions and dePressions
before World War II. So far, there
P Yirllall’ I
Hypothetical Business CYcles
(
E
0)
c)
o
o Jn
E LU
have been recessions but no depressions, so things
have improved. has grown dramatically over the longterm’The econ-
o*y-rro* produces about r3 times more outPut than changes due to infiation, which is an increase in the
economy’s average price level. Production increased
because of (r) increases in the amount and quality
of resources, especially labor and capital; (z) better property rights, patent laws, the legal system, and
market practices. in reai GDP as an upward-sloping straight line’ vious expansion has reached a peak, or high point,
and coniinues until the economy reaches a trough, subsequent peak is an expansion’ Note that expan- the fuli cycle varies. backto igs+. Since then, the nation has experienced
3z peak-to-trough-to-peak cycles’ No two have been
exactiy alike. During the 22 business cycles prior to
1945, expansions averaged z9 months and contrac-
tions zr-months’ During the rr cycles since 1945′ recessions fell by half to r r months’ Thus since 1945
expansions are longer and recessions are shorter’ economic grtwttr and the U.S. standard of living’ The
E d E longest exPansion on record
lasted ro years, from March Exhibit z shows annual as red bars and Years of 3.4 percent a Year- Although expanslon contraction depressron recegsion inflation CHAPTER 5 lniroduction to Macioecononiics 71 20
15
a €o -10
Exhibit z 1930 1940 1950 1960 1970 lel
SoIJRCE: Bureau of Economic Analysis, U.S. Dept ol Commerce’ For the latost data, snowstorm or a Poor As noted, fluctua- was a wofidwide calanrtry’ Ttre -urrerrrpluyrrrttrrt’Ia’te
in Germany reached 34 percent, which helped bring
Hitler to power. The following section compares the The Global Economy “.tori experience of two leading economies-the United each economy the year-to-year percentage change in in each economy, you can see some similarities’ Both the countries’ gtowth rates have fluctuated less and
become more similar. in one major economy could worsen a recession in line travel and lowering stock market prices’ On the u, b
Leading Economic lndicators I 3 The intensity ol !.S’ economic ttucruatrons vanes that produce capital goods, such as heavy machinery
and durable goods, such as appliances, furniture, and
automobiles. The demand for these goods falls more
during hard times than does the demand for other ind haircuts. In addition, housing, banks and finan- Because of sea- bances, the econ- cycle. Economists productionfrom tion may result slowdown, such as a
9/l1 attacks
72 PART 2 Fundamentals ol l/acroeconomics
f
o
c)
(E
O)
c)
(‘,
o
o
O
Despite these ups and downs, the U’S’ economy
it did in 1929. Output is measured by real GDq the
value of final goods and services after stripping away
technology; and (:) improvements in the rules of the
game thit facilitate production and exchange, such
-as
Exhibit r shows such a long-term growth trend
Economic fluctuations reflect movements around
this growth trend. A contraction begins after the pre-
or low point. The period between a peak and trough
is a contraction, and the period between a trough and
sions last tonger than contractions, but the length of
Analysts at NBER have tracked the U’S’ economy
expansions stretched twice as longto 57 months’ and
goih developments have been hugely beneficial for
I
q
r99r to March zoor. The lon’
gest contraction lasted five
and a half Years, from 1873
to 1879.
percentage changes in real
GDP since 1929. Years of
declining real GDP are shown
increasing real GDP as biue
bars. The big decline during
the Great DePression of the
early r93os and the sharP
jump during World War
II stand in stark contrast’
Growth since r9z9 averaged
official data are not Yet avail-
able, eventuallY the zoo8-
2oo9 recession will appear
on charts like Exhibit z.
a period during whieh
the economY’s oulPut
increases
a period during whieh
the economY’s outPut
tleclines
a sharp reduction in an
economy’s total *utPut
accompenied bY high
unemployment lasting
r$ore than a Year
a sustainad decline in
the economY’s tota!
a$tp{rt lasting at least
two consecutive quar-
tevs, or six months; an
ecsnomic contraciion
an increase in the
*conomy’s average
price level
E’o
c)
o.
;5
o,
c
G
c-5
C
Annual Perceilage Ghange in U.S’ Eeal GDP Since 1929
go to
growing season. T\rrn-
ing points-peaks and
troughs-are thus iden-
tified by the NBER onlY
after the fact. Because a
recession means outPut
deciines for at least two
consecutive quarters, a
recession is not so des-
ignated until at least six
months after it begins.
tions usually involve the
entire nation. lndeed,
major economies around
the worid often move
together. For examPle,
the Great DePression
year-to-year output changes in the United States
with those in another major economyr the United
Kingdom, during the last three decades.
Though business rycles are not perfectly synchronized
countries, a tink is often apparent. Consider the
Stites and the United Kingdom. Exhibit 3 shows for
real GDP since 1978. By examining the annual changes
economies went into recession in the early r98os, in
r99r, in zoot, and in zoo8. Notice also that over time,
\Mhen iinkage across economies occurs’ a siump
the other, and vice versa. For example, the terror-
ist attacks on the United States in September 2oor
affected economies around the world, reducing air-
other hand, economic strength overseas can give $
the U.S. economy a lift, with overseas profits help- E
ingcompanies offset aweakhome market’The same H
p”it”.., of worldwide decline occurred with the hous- !
ing and banking crisis of zoo8*zoo9. g
Certain events foreshadow a turning point in “to-
nomic activity. Months before a recession is under 6
across regions. A recession hits hardest those regions
goodsand sennices, such as breakfast cereal, gasoline,
ciai institutions particularly suffered in zooS
sonal fluctuations
and random distur-
omy does not
move smoothly
through Phases
of the business
can’t always dis-
tinguish a tem-
porary drop in
the beginning of
a downturn. A
drop in Produc-
from a temPorary