Review chapter 17 ("The Economy: Concepts and History") and chapter 18
("Principles of Economic Behavior: Microeconomics and
Macroeconomics") in Contemporary Society.
Why do market economies require forms of
What is inflation?
What are the functions of fiscal and monetary
What is the difference between fiscal and
What is the purpose of the Federal Reserve Bank?
In international trade, what kinds of protectionist
policies do nations adopt?
Why do they do so?
“Regulation” in this context means government
intervention into (“regulation” of) particular
parts of the economy. “State” regulation is
regulation by the sovereign state; for example,
regulation of the US economy by the US
“The results produced through market
mechanisms are not always compatible with
societal goals.” So, market economies
sometimes have to accept (public) government
A desirable mix of economic output
High and equitable distribution of incomes
Reasonable price stability
Adequate economic growth
Fairness for all citizens
Protection of workers and consumers
Generally speaking, government intervenes
through fiscal policy, monetary policy or through
Price inflation occurs when demand for a
product or products cannot be matched by
supply (so that currency has less buying
Price deflation occurs when there is more
supply of a product than demand for it
(currency has more buying power, but your
assets are worth less, and you are probably
paid less—because deflation will apply to
labor and employment as well).
Refers to government incomes (taxes) and
outputs (expenditures). It is regulation of the
economy on the basis of the taxing and
spending policies of the government.
Fiscal policy is most often directed toward
the goals of full employment and price
Can be used to combat inflation by reducing
The use of money and credit controls to affect
Government can regulate banks (credit) by
increasing or decreasing the “reserve ratio”
necessary for banks, i.e., the ratio of reserve
money a bank holds against the amount it lends.
For example, if a 1:10 ration is required, then a
bank must have in reserve at least 10% of the
amount it has loaned out. The required ratio
could be increased or decreased with a
consequent effect on the amount of money in
Government can also regulate the economy by
controlling interest rates. Low interest rates will
increase borrowing and thus increase economic
Monetary policy is mainly under the direction of
the Federal Reserve Bank (Fed). Note that the
Fed has held its discount interest rate as low as
possible since the time of the financial crisis, in
an effort to stimulate the economy. It has had
limited effect, however.
Principal regulator of the money supply
The Fed can increase or decrease bank reserves (i.e.,
how much money banks have available to lend) by
buying or selling government securities (e.g., bonds).
Effect on economy depends on (1) interest rates being
responsive to bank reserves and (2) how responsive
the economy is to interest rate changes. For example,
(as per the previous slide) in the wake of the financial
crisis the economy has not responded all that well to
low interest rates.
The use of wage and price controls to try to
direct economic outcomes (such as inflation).
Used when monetary and fiscal policies fail to
achieve the goals of full employment and
reasonable price stability.
Types of protective measures: tariffs, import
quotas, licensing requirements, export subsidies
Goal: boost exports and impede imports
Reasons: political pressure from domestic
industries—protect industry profits, protection
ofAmerican jobs, fostering fledgling industries,
There is a steady trend away from protectionist
policies, in the name of free trade.