Factors that Influence the Business Cycle

1. Factors that Influence the Business Cycle • Supply shocks - unexpected disruption in the economy that causes shifts in prices, economic activity, and employment. • Examples of good supply shocks... • new microchip technology that lowers the costs of computer technology • exceptionally good growing season • elimination of import tariffs

2. Factors that Influence the Business Cycle • Examples of bad supply shocks… • terrorist attacks • labor strikes • droughts • oil embargoes • wars that disrupt imports • direct effects on specific market -- ripple effects on other markets -- affect the whole economy

3. Factors that Influence the Business Cycle • The Federal Reserve - central bank in the U.S. whose Board of Governors is appointed by the president with consent of the Senate. The Fed… • protects the solvency of the banking system • promotes commerce

4. The Fed controls the money supply • Manipulating Interest Rates • The r that the Fed charges banks for short-term loans • Changing bank reserve requirement • % of dollar deposited banks must keep • Changing bank reserves • Buying and selling Treasury securities

5. Factors that Influence the Business Cycle • With respect to the money supply, the Fed can decrease interest rates (which increases money supply) • which in the short run (i.e., <12 mths)… • increases economic activity • increases employment • increases household income • which in the long run (i.e., > 12 mths)… • increases inflation

6. Factors that Influence the Business Cycle • With respect to the money supply, the Fed can increase interest rates (which decreases money supply) • which in the short run (i.e., <12 mths)… • decreases economic activity • decreases employment • decreases household income • which in the long run (i.e., > 12 mths)… • decreases inflation

7. A note on Wealth and Labor from Adam Smith(reference Reading Packet) • “Every man is rich or poor according to the degree in which he can afford to enjoy the necessities, conveniences, and amusements of human life.” • Our own labor can only do so much for us; we need others’ labor to bring us the joys of life.

8. Wealth is determined by how much labor we command, either our own labor or others • The value of any commodity is equal to the quantity of labor which is required to possess it.

9. The “REAL” Price • “The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.” • What we buy with money, we are really buying with our labor • “Labor was the first price, the original purchase-money that was paid for all things. It was not by gold or silver, but by labor, that all the wealth of the world was originally purchased;”

10. Using labor to measure prices • Gold, silver and money always have varying values. One cannot use a commodity to measure another commodity if the values are continually changing. • However, equal quantities of labor are of equal value to the laborer. The price paid (labor) is always the same. • Labor is alone the ultimate and real standard by which the value of all commodities can be compared. • Labor is the real price, money is their nominal price only.

11. Measuring Labor • Although labor should be the real measure of the value of all commodities, it is difficult to ascertain between two different sorts of work. • The market sets the value of the different labors by bargaining.