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Final Exam Study Guide

by: Samantha Pruser

Final Exam Study Guide ECON 222 001

Samantha Pruser
GPA 3.8

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Final Exam Study Guide Follows the review posted by Dr. Chandini
Principles of Macroeconomics
Chandini Sankaran
Study Guide
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This 19 page Study Guide was uploaded by Samantha Pruser on Monday December 7, 2015. The Study Guide belongs to ECON 222 001 at University of South Carolina taught by Chandini Sankaran in Summer 2015. Since its upload, it has received 434 views. For similar materials see Principles of Macroeconomics in Economcs at University of South Carolina.

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Date Created: 12/07/15
Chapter One Macro v Micro Microeconomics is the study of how households and firms make choices Macroeconomics is the study of the economy as a whole Scarcity : a situation in which unlimited wants exceed the limited resources available to fulfill those wants Four Economic Resources 1. Land: all natural resources (as well as what comes with land) 2. Labor: workers physical and mental abilities (quality) as well of number of workers (quantity) 3. Physical Capital: tools, machines, factories, building, produced factors of production 4. Entrepreneur: Organizes resources for production, innovation and risk taking Factors of Production Land Labor Physical Capital Entrepreneurs Rent Wages Loans Profit Interest s Firms Firms Firms Firms Blue arrow= Input to firms Red Arrow = Output of firms (Back to household/consumer) Input v Output Input- Production, technology Output- tangible good, intangible service Goods v Services - Goods are tangible and consumable - Services is the process of offering your ability to perform/ instruct/ create something or do something for someone Business Cycles :Short Run GDP - Peak (high point) Peak of a business cycle= top of a curve - Trough (low point) Up = Economic expansion or boom Down = Economic recession Efficiency v Equity (General definition) each resource is used or allocated in a way that it serves each person as well as possible while minimizing waste Productive Efficiency: where goods or services are produced at the lowest possible cost Allocative Efficiency: Where production is consistent with consumer preferences: the marginal benefit of production is equal to its marginal cost - Both of these types are promoted by market economies Equity: In economic terms, the concept of what is fair (general welfare, taxes etc.) Market Failure: Market does not reach the best outcome on its own, government intervention can improve a market’s outcomes 1. Externality- the impact of one person’s actions on the well-being of a bystander Positive Externality: Impose external benefits Example: Finding a lottery ticket on street, it wins jackpot Negative Externality: Impose external costs Example: Dumping toxic waste into a public river, smoking in a crowded classroom 2. Excessive Market Power Monopoly: One seller of a good or service, Price maker Oligopoly: a few large firms Natural Monopoly: electricity, very high startup costs, all houses need wires and cables Example: utility companies, electricity 3. Equity: Free markets are efficient but not equitable 4. Government: Provides goods and services that a private market will not provide (called public goods) Public good- Nonexcludable (Cannot prevent a person from using) and Nonrival (One person’s using will not diminish another person’s use) Private Good- excludable (Can prevent a person from using) and rival(One person’s use will diminish another person’s use) o For a private market to produce a good it needs to be excludable 5. Enforce Laws, Contracts and Property Rights: The rights individuals or firms have to the exclusive use of their property Adam Smith - Believer in Market Economies (early capitalist) - Property is privately owned and markets determine what quantities of goods and resources are sold - Wrote “Wealth of nations” (1776) Marginal Analysis Marginal Cost- how much firms are currently spending producing the good Marginal Benefit- how much competitors value the good Analysis Positive Analysis: the study of “what is.” Factual and can be supported by evidence, describes world as it is Normative Analysis: Study of “what ought to be.” How you think the world should be, prescriptive, personal values, views and judgements, cannot be tested in order to be proven true or false Examples: 1. War is bad (Normative) 2. Barack Obama is better looking than Donald Trump (Normative) 3. Spending on national defense has increased since September 2001 (Positive) Types of Economies Centrally Planned Economies: governments decide what to produce, how to produce it and who received the goods and services Example: Soviet Union (USSR), North Korea and Cuba Market Economies: Result when the decisions of households and firms determine what is produced, how it’s produced and who receives the goods and services Mixed Economies: features of both the previous economies Example: United States of America and China Chapter Two Production Possibilities Frontier for Tesla Productivity A) 80 sedans and 0 SUVs C) 0 sedans and 80 SUVs 1 hour = 2 sedans E) 40 sedans and 40 SUVs 1 hour = 2 SUV’s 40 work hours available Feasible points are on the PPF Unfeasible Points are not A (80,0) 80 (G) is an unfeasible point, cannot produce that C (40,40) - Inefficient points fall below the PPF 40 G Not possible production - Efficient points are along the PPF E (0,80) 0 40 80 Opportunity Cost of Moving along the PPF - Opportunity Cost (OC)- the highest valued alternative that must be given up in order to engage in an activity/ what you give up to get something - Opportunity cost of 20 SUVs = 20 sedans o Moving from B to C = 20 sedans (OC) o OC of one SUV = one sedan o Essentially this is just calculating the slope o Constant OC for straight line PPF Circular Flow Diagram (CFD): Model that illustrates how participants in markets are linked Markets for goods and services Product Market _________Market for Output___________ Households Firms CFD Resource Market/ Factor Market Flow of Resources Flow of Dollars Flow of Goods and Services Markets Product Market- markets where goods like computers and services such as medical treatment are offered (Firms are sellers and households are buyers) Factor Markets- Markets where Factors of Production such as land, labor, capital etc. are traded Comparative Advantage - Lowest opportunity cost of producing a good Girl 1 apple = 1 hour Boy 1 apple = 20 hours 1 cherry = 8 hours 1 cherry = 10 hours *40 work hours available for both* Girl___________________________________________________________________________ Apples A 40 A = Production Point with Trade 30 D C = Consumption Point and Production Point without Trade D = Consumption Point with Trade 20 C B 0 2.5 3 5 Cherries Girl Without Trade With Trade Production Point 20 apples and 2.5 cherries 40 apples and 0 cherries Consumption Point 20 apples and 2.5 cherries 30 apples and 3 cherries Boy_____________________________________________________________________________ apples 10 D A = Production Point with Trade 2 C = Consumption Point and Production Point without A Trade D = Consumption Point with Trade 1 C B 0 1 2 4 cherries Boy Without Trade With Trade Production Point 1 apple and 2 cherries 0 apples and 4 cherries Consumption Point 1 apple and 2 cherries 10 apples and 1 cherry - Girl has absolute advantage in both apples and cherries Girl Boy 8 hours = 1 cherry 10 hours = 1 cherry 1 hour = 1 apple 20 hours = 1 apple ____________________Equalize hours_____________________________ 1 cherry = 8 hours 1 cherry = 10 hours 1 apple = 1 apple 1 apple= 20 hours _____________________Find Opportunity Costs_____________________ 1 cherry = 8 apples 1 cherry = ½ apple 1 apple = 1/8 cherry 1 apple = 2 cherries Chapter Three Gains from Trade Step One: If a graph is provided, look at the axis. If a table is provided, carefully read the table. Item Labor hours needed to produce 1 unit Beer 5 hours 6 hours Sausage 8 hours 12 hours US 5 hours = 1 Beer Germany 6 hours = 1 Beer 8 hours = 1 Sausage 12 hours = 1 Sausage Pounds Production Item Pound(s) Production per hour Beer 5 Beers 6 Beers Sausage 8 Sausages 12 Sausages Step Two: Absolute Advantage - Who produces more in the same amount of time - Whoever takes less time to produce the same amount of the good Step Three: Comparative Advantage - If one producer has an absolute advantage in both goods calculate opportunity cost - The lower opportunity cost producer of a good has comparative advantage in that good - If one producer has an absolute advantage in one good the other producer has an absolute advantage in the other good o Then that is what they will have their comparative advantage in Step Four: Compare consumption point before and after trade to calculate the gains from trade Types of Goods Normal goods- Demand for normal goods increases as income increases Complement Goods- Increase in price of complement good makes demand for normal goods go down Substitute Goods- Increase in price of a normal good makes the demand for a substitute good Increase Finals Goods and Services Final Good- Good or service purchased by the final user (at it’s end use) Intermediate Goods- goods used up in the production of another good Supply and Demand Curves Key Relationships Demand increases Price increases Demand Decreases Price decreases Supply Decreases Price Increases Supply increases Price Decreases Chapter Eight Gross Domestic Product total market value of all final goods and services produced in a country during a specific period of time, typically a quarter or a year - Gross domestic product reported by the bureau of economic analysis (BEA), part of the department of commerce, calculated quarterly Included in GDP 1. Produced in the boundaries of our county - Includes exports 2. Newly produced 3. Sold legally in markets 4. Rent and estimated Rental Value of owner- occupied houses 5. Final goods services: household buys things for consumption, physical capital final Excluded from GDP 1. Value of intermediate goods 2. Second- hand goods 3. Illegal production 4. Items produced at home and never enters the market 5. Transfer payments (Social Security Check) Calculation of GDP 1. Resource Cost or Income Approach: Wage + Rent + Profits + Interest 2. Expenditure Method: Y = C + I + G + NX (GDP = Consumption + Investment + Government Purchases + Net Exports) 3. Output Method: total dollar value of output produced (Most likely to be on Exam) P x Q = GDP Trade Trade Surplus NX+ = X > M Trade Deficit NX- = X < X Shortcomings of GDP 1. Household Production: childcare, cooking and cleaning, If done by a non-household member then it adds to the GDP 2. Underground: 10% or more of the economy in America 3. The Value of Leisure 4. Happiness 5. Pollution or quality of environment 6. The distribution of income 7. Crime and social problems Calculations Using the Output Method Output Method: Dollar Value of Output Nominal GDP- the value of final goods and services evaluated at current-year prices Real GDP- the value of final goods and services evaluated at base-year prices EXAMPLE: 2011 Q P NGDP2011 Timber 50 x $20 = $1,000 2012 Q P NGDP2012 Timber 50 x $30 = $1,500 1. Real GDP- adjusted for inflation (fix prices at the base) RGDP11= P11 x Q11 = $20 x 50 =$1,000 RGDP12= P11 x Q12 =$20 x 50 =$1,000 RGDP13= P11 x Q13 =$20 x __ =______ 2. GDP Price Deflator NGDP11 x100 (nominal GDP) RGDP11 (real GDP) EXAMPLE: GDP Price Deflator11 1,000 x 100 =100 1,000 GDP Price Deflator12 1,500 x100 =150 1,000 - In the base year, NGDP=RGDP o GDP price deflator is always 100 in the base year 3. Inflation Rate- the percent change in GDP GDP deflator 2012 (new) - GDP deflator 2011 (old) x100 = Inflation GDP deflator 2011 (old) Chapter Nine Consumer Price Index Consumer Price Index: measure of the average change over time in the prices of a typical urban family of four pays for the goods and services they purchase - Increase in CPI means inflation - Decrease in CPI means deflation Consumer Price Index Calculation To calculate the CPI in a given year we need: 1. Fix the basket of goods: establish a “market basket” of goods and services that they typical consumer buys. 10 bananas, 20 backrubs and 40 margaritas 2. Find the prices in the earlier (base) year and calculate the cost of purchasing this fixed basket (COB) 3. Find the prices in the current year and calculate the cost of purchasing this fixed basket in the current year 4. Calculate CPI=COB Current x100 COB Base 5. Calculate inflation rate as the percent change in the CPI CPI Current- CPI Base x 100 CPI Base CPI Weaknesses (Tends to overstate inflation) Substitution Bias: consumers may change their purchasing habits away from goods that have increased in price Increase in Quality Bias: Cars and computers have become more durable over time. Hard to isolate the pure- inflation part of price increase New Product Bias: The basket of goods used to change only every 10 years, delay to including new goods Outlet Bias: Increases in purchases from discount structure (EX: Costco) or the internet are not computed into CPI, it still uses full-retail prices Labor Force Structure Working Age Population 254.9 million 1.Labor Force 2.Not in labor force a. Employed a. Not available for work b. Unemployed b. Available for work -(Discouraged workers, etc.) Employed- spent a few hours of the week working at a paid job. Paid employees, self-employed and unpaid workers in a family business Unemployed- people not working who have looked for work during the previous four weeks, Actively seeking and willing to accept a job, recently laid off or waiting for a start date of a job Not in labor force- everyone else, people who do not have paid jobs and are not looking for jobs Unemployment Types Cyclical Unemployment: Short-Run fluctuations in the UE rate. Month to month of year or year associated with business cycle fluctuations, with the short-run ups (booms and expansions) and downs (recessions and contractions) of the economy Natural Rate of Unemployment: The normal rate of unemployment consisting of frictional unemployment and structural unemployment (rate that economy normally/ typically experiences, between 5 and 6 percent) 1. Structural Unemployment 2. Frictional Unemployment Calculations Regarding Unemployment EXAMPLE: Unemployed = 11.3 million Labor Force = 155.5 million Working age population = 245.9 million Labor Force = #employed + #unemployed Adult Population = #employed + #unemployed + #not in labor force aka: ( #Labor force + #Not in labor force) Unemployment Rate = # Unemployed x 100 # Labor force Labor Force Participation Rate (LFPR) = #labor force x 100 #adult population Employment Population Ration (EPR) = #employed x 100 #adult population - (EPR is the percentage of the working age population that is unemployed) Background of Unemployment Rate - Unemployment rate is the most watched of all labor force statistics o aka the percentage of the labor force actively searching for jobs - The household survey/ current population survey o Conducted by the Bureau of Labor Statistics o Every month o Survey 16,000 randomly selected households o 16 and older Unemployment Rate Shortcomings 1. Not a perfect measure 2. Understates unemployment 3. Hard to distinguish between Unemployment and Not in labor force o Judged on job search efforts 4. Discouraged workers are currently counted as Not in Labor Force (NLF) o Should they we considered unemployed? 5. Does not measure the intensity of employment o Some people are underemployed, but counted as employed even if they want full time employment 6. Overstate Unemployment o Some may claim to be unemployed even if they are paid o Claim to be Unemployed but nor in labor force  Claim Unemployment to get government benefits o Broader measure of Unemployment is a category called U-6  Counts discouraged workers and underemployed workers Chapter Ten Economic Prosperity and Health - Countries that are prospering economically see better health in residents and more leisure hours in each day - High GDP has a direct relationship with a lot of leisure time and good health GDP Growth Rates Equation: New GDP – Base GDP x 100% Base GDP - To find growth rate of more than one year of GDP, add them all up on top of equation and divide by the number of years there are total Equation: GDP2011 + GDP2012 + GDP2013 x100 3 Factors Affecting Labor Productivity Growth Productivity: the quantity of goods and services that can be produced by one worker or in one hour of work 1. Capital: manufactured goods that are used to produce other goods and services (these are already produced factors of production, meaning they are not raw) a. Physical Capital: tools, machines and buildings EXAMPLE: For a fisherman physical capital would be his boat and net b. Human Capital (HK): knowledge and skills that humans acquire through training EXAMPLE: For a fisherman the knowledge of how to catch a fish and the skill of casting a reel very far out 2. Natural Resources: Water and minerals, aka raw materials 3. Technological Knowledge: a new innovation that has just been invented and helps a firm become more productive EXAMPLE: In 1939 when Henry Ford invented the assembly line 4. Public Policy a. Promote and maintain political and social stability- a country in a war does not have workers fully focusing on going into work everyday (MOST IMPORANT of 6) b. Encourage education and training c. Outward oriented policies- open economies d. Control population growth e. Research and development f. Encourage savings and investment (investments being the firm’s purchase of physical capital) Potential GDP - Potential (Real) GDP rises every year when the labor force expands and new technologies and innovations are invented - On average the US Real GDP rises by 3.2% (roughly) every year Financial System and Loanable Funds 1. Financial Markets: institutions which a person who wants to save can directly supply finds to a person who wants to borrow a. Bond Market: a type of debt financing includes a specified interest rate, interest paid depending on credit risk of the company Interest depends on a) Credit Risk b)Term to maturity c)Tax treatment EXAMPLE: Google Bonds will be much more stable than that of a startup b. Stock Market: Returns vary, depends on how well or poorly the firm does (Tied to equity and finance) 2. Financial Intermediaries a. Banks- take deposits from savers and makes loans to borrowers b. Mutual Funds- institutions that sell shares to the public and uses the proceeds to buy portfolio of bonds and stocks Key Services of Financial System 1. Risk Sharing 2. Liquidity 3. Information The Macroeconomics of Savings and Investments - Total value of saving in the economy must equal the total value of investment in the economy Equations: Y = GDP of a nation Open Economy Trades: Y = C + I + G +NX I = Investment Closed Economy Trades: Y = C + I + G C = Consumption Household Income: = Y + TR G = Government Purchases Disposable Income: Y + TR – T = C + SP SP = Private Savings Private Savings: SP = Y + TR – T – C SG = Public savings Public Savings: SG = T – G - TR TR = Transfer payments Market for Loanable Funds Market for loanable funds: a conceptual interaction of borrowers and lenders determining the market interest rate and the quality of loanable funds exchanged Supply of Loanable Funds Equilibrium interest rate Demand of Loanable Funds This graph illustrates QSLF = QDLF - (Based off the investments quantity of loanable funds) Supply of Loanable Funds Demand of Loanable Funds #2 Equilibrium interest rate Demand of Loanable Funds This graph illustrates the government implementation of an investment tax credit (Giving tax breaks to those who invest which enriches the economy) - This shifts the DLF1 to DLF2 (aka increases demand) Chapter Fourteen Types of Money Commodity Money: has a value independent of its use as money (has intrinsic value/alternative uses) EXAMPLE: gold parts, cowrie shells (Asia), beaver pelts (precolonial America) Fiat Money: money that doesn’t have alternative uses/no intrinsic value EXAMPLE: US dollars M1 and M2 M1- US Money Supply 1. Traveler’s Checks- in place of cash, meant for traveling 2. Currency- dollars and coins 3. Checking Account deposits M2- Broader definition of money supply (Less liquid than M1) 1. Savings Accounts Deposits 2. Money market Mutual Fund Shares 3. Small denomination time-deposits- like a savings account, cannot access online What is and is not as money? Has to fulfill these 5 qualifications 1. Acceptable 2. Standardized Quality 3. Durable 4. Valuable 5. Divisible Functions of Money 1. Medium of Exchange: money is acceptable in a wide variety of places as a form of payment in exchange for goods and services 2. Unit of Value: money allows a way of measuring value in a standard manner. Each good has a price in terms of dollars which enables us to compare different value of goods 3. Store of Value: Money allows people to defer consumption until a later date by storing value. Enables us to transfer our wealth from today to sometime in the future. Other assets can do this too but money does it particularly well because it is liquid 4. Standard of Deferred Payment: In borrowing and lending exchanges between people over time (creditors and debtors) Banking Systems - 100% Reserve Banking- when banks keep reserves consisting of every single dollar deposited (not realistic b/c banks would make no money) - Fractional Reserve Banking System- commonly used, banks only keep a portion of what is originally deposited into them Reserves Reserves: deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve Required reserves: the minimum amount of deposits that the bank must keep in their vaults or with the Federal Reserve (currently 10%) Calculations with Reserves EXAMPLE: One person in the economy deposits $1,000 100% Reserve Banking: The bank would be required to hold onto all 1,000 dollars Fractional Reserve Banking: The bank would only need hold onto 100 of the dollars deposited - That money continues to be loaned out and deposited over time, in other banks EXAMPLE: Person 1- Deposits $1,000 (of currency = M1) Deposits Loans Reserves Branch 1 $1,000 $900 $100 Branch 2 $900 $810 $90 Branch 3 $810 $729 $81 - Beginning M1 was 1,00- (what was originally deposited) - End M1 = $1,000 + $900 + $810 = $2,710 - This exhibits Money Creation by Banks Simple Deposit Multiplier SDM = 1_ RRR - This equation tells us the amount of money that is going to be created by banks under the fractional reserve banking system EXAMPLE: 10% RRR and $1,000 in currency deposited $1,000 x _ 1_ = $10,000 0.1 - So, $10,000 is the amount of money created by banks Federal Reserve System 1914- The Federal Reserve System was created (“The Fed”) 1. Regulate banks- setting RRR, checking their accounts 2. Act as a lender of last resort to banks by making loans called “discount loans” and charging a rate of interest called “discount rate” 3. Control Money Supply (MS)- amount of M1 circulating in the hands of the public - Janet Yellen (Current chair of Federal Reserve, Ben Bernanke is the previous) Federal Reserve Structure - 1 Chair and a Board of Governors - Chair has renewable 4 year terms - Board of Governors divided into 12 districts and Federal Open Market Committee (FOMC) o Each have a regional bank in it FDIC (The Federal Deposit Insurance Corporation) - January 1934, Congress established The Federal Deposit Insurance Corporation (FDIC) o Through the banking act of 1933 o Insures deposits in a bank up to a limit ($250,000)  For each deposit ownership category in each bank  Designed to increase confidence in banks Tools to Control Money Supply Three Monetary Supplies of the Fed. (Monetary Policy tools) 1. Change the reserve requirements - Increase the RRR banks have to keep more of their deposits on them as reserves and cannot make as many loans, decrease money multiplier and decrease overall money supply - Decrease the RRR, Increase money multiplier and therefore increase the overall money supply 2. Discount Policy: The discount rate is the interest rate paid on money that banks borrow from the Fed. - Lower Discount rate, cheaper for banks to borrow money from the Fed, banks to borrow money from the Fed, banks lend out more money to the US (Increases MS, Increases the Discount Rate) therefore it becomes more expensive for banks to borrow from the Fed (decrease in MS) 3. Open Market Operations: most common FOMC, the buying and selling of treasury securities by the Fed. In order to control MS. The Fed directs its trading desk (open market deal) in New York to buy and sell US Treasury Securities Treasury Bills- short term, 1 year or less Treasury Notes- medium term, 2-10 years Treasury Bonds- long term, 30 years a. Open Market Sale: Fed selling treasury bills/securities (decrease in MS) b. Open Market Purchase: Fed buying treasury securities (Increase in MS) Shadow Banking System 1. Investment Banks: banks that do not typically accept deposits form or make loans to households. They provide investment advice or engage in creating and trading securities, such as mortgage- backed securities 2. Money Market Mutual Funds: funds that sell shares to investors and use the money to buy a combination of stocks and bonds. Normally short term treasury bills and commercial paper (loans to corporations and mortgage- backed securities) 3. Hedge Funds: Funds that raise money from wealthy investors and make “sophisticated” (non- standard, riskier) investments Classical Dichotomy of Money EXAMPLE: - An economy produces 100 bushels of wheat Price per bushel ($10) One $50 note circulating in the economy (M=50) $10= P - In nominal terms (In dollars) we produced P x Y = (10) x (100) = $1000 NGDP MV = PY which means that V = P x Y M V= 1000/50 = 20 Financial Crisis of 2007-2009 - Lehman Brothers failed which started a panic - TARP- Troubled Asset Relief Program, started by the Fed in 2008 o Providing funds to banks in exchange for stocks Irving Fisher’s Contributions to Economics Early 20 century Irving Fisher formalized relationship between Money and Prices M x V = P x Y (Money supply x Velocity of Money = Price level x Real GDP, Real Output) Other Important Chapter 10 Definitions Security: Financial asset (EX: Stock/Bond) that can be bought/sold in a financial market Velocity of Money: the speed at which a dollar note circulates in the economy, the average number of times each dollar is used to purchase goods and services Hyperinflation: very high rates of inflation, in excess of 100% a year, sometimes 50% a month Chapter Eleven Quantity Theory Explanation of Inflation M x V = P x Y - When variables are multiplied together in an equation we can form the same equation with their growth rates added together Inflation Rate = Growth rate of Money Supply - Growth rate of Y Implications 1. If MS grow faster than RGDP, there will be inflation 2. If MS grows slower than RGDP, there will be deflation 3. If MS grows at the same rate as RGDP, the price level will be stable. There will be neither inflation nor deflation Classical Theory: describes the world in the long run - In long run it is believed that macroeconomic outcomes are stable John Maynard Keyes - “The general theory of unemployment, interest and money” Recessions Demand Shock Recession: Consumers and firms lose confidence in the economy Supply Shock Recession: caused by the increase in the price of a very important input (EX: crude oil) Fiscal Policy: Refers to changes in taxes and government expenditures Monetary Policy: Refers to changes in money supply During Recessions, the government can shorten the duration and severity of the recession by engaging in 1. Expansionary Fiscal Policy: Increase Gov. Expenditures and Decrease Taxes 2. Expansionary Money Supply: Print more money (Increase Money Supply), which causes people to spend more Employment Act of 1946 1. Government should respond to changes in private economy to stabilize demand 2. Government should avoid being the cause of economic fluctuation Should the Government Balance the Budget? Yes- This point of view is mostly because people want to save our future generations from massive debt (we are currently at 17 trillion) No- Some economists believe this is a way of spreading out cost among generations, the biggest cost is WAR


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