Question

When we talk about whether there is prosperity or not, we are generally talking about the amount of the gross domestic product that goes to each person. Standard of living, meanwhile, refers to the extent to which the economy in a region enables the production of and purchase of goods and services.

The financial system, meanwhile, is the group of institutions dealing with savings and borrowing of money, made up of financial markets and financial intermediaries. The stock and bond markets of a country are the financial markets, while financial intermediaries include banks and mutual funds. You, for example, can use a bank to take out a house loan, in exchange for interest payments on the principles of that loan. That money is taken from the collective savings of bank customers, which often are paid interest for money put in at the bank. Publicly traded companies, meanwhile, use the money you use to buy shares in the company to fund operations and expansion, in exchange for a cut in the profits made by those companies. Of course, if you invest, there is always a risk that the company will lose money and not generate profits - sometimes even shrinking in size and scope of operations. Stock prices are supposed to be based on rational information under the efficient markets hypothesis, but some economists would argue that irrational psychological factors also influence the prices of stocks.

Unemployment and inflation are also unfortunate realities of the economic system. Inflation is the general rise in prices. When I was young, one could easily buy a house for under $100,000 in the area around LASC. Today, a house in Los Angeles for under $500,000 is a rarity, and most are probably well beyond that. Unemployment comes when there is not enough production, which is often a reflection of a lack of consumption, often linked to inflation. As a means of stimulating economic growth, the Federal Reserve may increase or decrease the supply of money in the system, manipulating interest rates at the national level.

Respond to both of the following prompts:

1. The United States has been considered one of the strongest economies in the world for nearly a century now, with one of the highest standards of living in the world. However, within your lifetime there was a drop in economic well-being due to a massive recession stemming from a combination of a tremendous housing bubble coupled with a subprime lending scheme by some of the biggest banks, compounded by high personal debt domestically and globalization-based trade deficits causing a meltdown of the economy. We have recovered fairly well and as far as economic activity goes, we went beyond where we were before the recession, making it the strongest economy in history. However, things are never perfect and inflation, unemployment, and economic struggles come back in a cyclical manner. Based on the reading, what do you think are some steps that could be taken to bring the U.S. economy to its strongest position and curtail future recessions and economic meltdowns? Other than GDP, how else might you determine how strong an economy is?

2. Think of three food items that you eat on a regular basis. Find out what the price of those three products are today. Then, do an internet search to try to find out what the price of those three products were in 1998. What does this tell you about inflation for those products? Did any actually deflate in value? What might have caused this inflation or deflation? Also, try looking up the average salary in 1998 versus today. What differences do you see there? Is the inflation consistent with the salary increases or does one outpace the other?

Answer 1

Key points from the case:

Gross domestic products per person and standard of living reflect economic performance and improvement in peoples life.Banks accept deposits and give loans . Financial institutes also borrow and expand businesses. When people invest in shares there is risk of losing money.

Inflation is sustained increase in price levels. Unemployment generally happens when there is no demand in an economy and central bank can initial policies to tackle these problems.

Question 1 answered:

When there is inflation and central bank wants to reduce over consumption in an economy then it increases interest rates and decreases money supply. This is called as contractionary monetary policy.

When there is recession and central bank wants to boost economic activity then it decreases interest rates and increases money supply. This is called as expansionary monetary policy.

Fiscal policy is a policy determined by the govt. and it has two tools: taxes and government spending.When there is recession and government wants to induce economic activity then it decreases taxes and increases spending. This is called as expansionary fiscal policy.

Currently USA is recovering from 2008 sub prime crisis. Government adopted expansionary fiscal policy and Fed had expansionary monetary policy. With these policies almost more than $3 trillion were pumped in an economy to shift aggregate demand to the right so that real GDP will increase, more jobs will be generated and a virtuous cycle of high income-high savings-high investments-high productivity will start and again economy will start expanding.

If USA people start making more USA based goods and reduce imports then US dollar value will appreciate and if imports are higher then USD will depreciate. US government is following protectionist policy to encourage domestic production and consumption. Tariff war with China and other trade blocs like EU is an example of this. USA is also reducing corporate taxes to make manufacturers shift production base back to USA. Due to high spending USA deficit is increasing.

Apart from GDP (USA has highest GDP in the world), USA has better Human development index, more than 0.92 (1 is best), which makes it very high human development country. The United States is ranked 8 among 190 economies in the ease of doing business, it shows its business friendliness. However, income inequality is increasing worldwide and in USA also.