We have learned about how the economy oscillates between recessions and expansions in which unemployment and inflation rise and fall. These fluctuations are not just lines on a graph or figures in a table; they affect our lives in dramatic ways. What causes these fluctuations? What, if anything, can be done to smooth out these business cycles so the economy continues to grow steadily with low unemployment and stable prices?
In this lecture and the following one, we will delve more deeply into short-term fluctuations in the economy and how government fiscal policy can influence unemployment and output. To do so, we will focus on the demand side of the economy and look closely at how changes in spending by households, firms, the government, and foreigners on domestic goods and services can affect the economy. Upon completion of this lecture, you should understand and be able to answer these key questions:
1. When you spend money at the mall, is that good for the economy? Does the amount of your income you spend cause an increase in someone else's income?
2. Do the spending habits of households like yours translate to the spending patterns for the economy as a whole?
3. How much of their extra income do people spend? How can we figure this out?
4. Besides spending on consumer goods, where else does money get spent in an economy?
5. Is there a difference between what an economy plans to spend and the amount that it buys?
6. How can changes in consumption or investment spending affect the economy? Can the economy change a lot with only a small change in spending habits?
7. How can spending get multiplied in the economy? How does this affect recessions and unemployment?