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Chapter 02 - Understanding How Economics Affects Business
2-61
PPT 2-54
National Deficits, Debt, and Surplus
NATIONAL DEFICITS, DEBT
and SURPLUS
2-54
LO 2-6
• National Deficit -- The amount of money the federal
government spends beyond what it gathers in taxes.
• National Debt -- The sum of government deficits
over time.
• National Surplus -- When government takes in
more than it spends.
PPT 2-55
What’s Our National Debt?
WHAT’S OUR NATIONAL DEBT?
2-55
LO 2-6
• The National Debt has reached nearly $18 trillion.
• If $1 bills were stacked, the National Debt would
would stretch over 1,000,000 miles. The moon is
only 238,857 miles away.
• Follow the U.S. National Debt Clock here.
1. Discuss with the class the size of the national debt and
what impact this has on the economy. (Increased bor-
rowing by the government takes money out of the con-
sumer and business markets, impacting the cost of bor-
rowing.)
2. The national debt has continued to increase roughly $2
billion per day since September 30, 2012.
3. On a per person basis, each citizen’s share of this debt
is over $56,000.
4. A family of four shares the debt burden of about
$224,000.
PPT 2-56
What Can a ___ Dollars Buy?
WHAT CAN a ____ DOLLARS BUY?
2-56
LO 2-6
• A million dollars can buy an Egg McMuffin and a
large coffee for President Obama and 2,000
Secret Service members every day for six
months.
• A billion dollars can buy Egg McMuffins and large
coffees for them for 489 years.
• A trillion dollars can buy Egg McMuffins and
large coffees for them for 488,992 years.
1. Before showing the slide, ask students, “If you were a
rich, generous person who wanted to treat President
Obama and his 2,000 Secret Service members to an
Egg McMuffin every morning, how many days could
you treat them if you decided to spend a million dol-
lars? A billion dollars? A trillion dollars?”
2. Students are usually surprised to see how much a mil-
lion, billion, or trillion dollars can buy.
Chapter 02 - Understanding How Economics Affects Business
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PPT 2-57
Monetary Policy
MONETARY POLICY
2-57
LO 2-6
• Monetary Policy -- The management of the money
supply and interest rates by the Federal Reserve
Bank (the Fed).
• The Fed’s most visible role is increasing and
lowering interest rates.
- When the economy is booming, the Fed tends to
increase interest rates.
- When the economy is in a recession, the Fed
tends to decrease the interest rates.
PPT 2-58
Test Prep
TEST PREP
2-58
• Name the three economic indicators and describe
how well the U.S. is doing based on each
indicator.
• What is the difference between a recession and a
depression?
• How does the government manage the economy
using fiscal policy?
• What does the term monetary policy mean? What
organization is responsible for monetary policy?
1. The three key economic indicators are the Gross Do-
mestic Product (GDP), the unemployment rate, and the
price indexes. Our high GDP allows citizens to enjoy a
high standard of living. In 2000, the U.S. reached it
lowest unemployment rate in over 30 years. However,
the recent recession could lead unemployment to at
least 10 percent. The consumer price index (CPI) has
not risen to high levels keeping inflation in check.
However the recession has caused fears of deflation.
2. A recession is two or more consecutive quarters of de-
cline in the GDP. A depression is a severe recession,
usually accompanied by deflation.
3. Fiscal policy refers to the government’s efforts to keep
the economy stable by increasing or decreasing taxes or
government spending.
4. Monetary policy is the management of the nation’s
money supply and interest rates. The Federal Reserve
controls the money supply in the United States.
Chapter 02 - Understanding How Economics Affects Business
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lecture
enhancers
“It’s a recession when your neighbor loses his job; it’s a depression when you lose your own.”
Harry S. Truman
“Three groups spend other people’s money: children, thieves, politicians. All three need paren-
tal supervision.”
Dick Army, politician
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INDIA’S UPCOMING ERA OF GROWTH
By all accounts, India is destined for massive growth over the next decade. Yet India is always
measured in the shadow of its neighbor and fellow burgeoning economic superpower, China. After all, by
2030 the two nations are estimated to account for 34% of the globe’s total economic output. Experts as-
sert that China will be on top, however, and is on target to overtake the United States with 24% of world
GDP by the same year.
But China’s massive growth could ultimately be hindered by its one-child policy. With popula-
tion escalation stunted, the pool of Chinese citizens eligible for work will shrink just as the nation surges
toward GDP dominance. India, on the other hand, will experience one of the fastest growths of working-
age populations in the world between 2010 and 2050. India’s upcoming spike of work-eligible citizens
could provide it with a much-needed advantage over not only China, but also the fully developed econo-
mies of the United States and Europe. Small countries with low birthrates like Sweden, Austria, and
Denmark could eventually drop off the list of the 30 biggest economies in the world. Instead, high popu-
lation and expanding nations like India could take up the economic mantle in the next decade and beyond.
First, however, India must suitably develop its crumbling infrastructure. Cracked roads and
bridges present the biggest impediment towards India’s growth. While the country nearly matched China
in total economic expansion in 2009 at 9.7%, its dire infrastructure is ranked 91st out of 139 nations, be-
hind Ethiopia and Indonesia. Even worse, despite its vast population India lacks the skilled labor to repair
and rebuild. Though laborers abound, many Indians look down on the profession since those jobs were
previously performed by lower classes. Therefore parents want their kids to upgrade to life as an engineer
rather than a mason or a carpenter. In an effort to combat their skilled worker shortage, Indian companies
are forming their own training schools that will hopefully convert standard laborers into capable contrac-
tors and foremen.i
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A NEW CROP OF CONSUMERS IN AFRICA
While a great deal of focus has been given to burgeoning economic superpowers like India and
China, Africa has a growing middle class that rivals both those countries. Thanks to open markets and
greater political stability, economists estimate that Africa’s middle class (those who spend $2–20 a day)
makes up 34% of the continent’s population. A new study shows that this 313-million-strong middle
class, which has grown 60% over the last decade, is upwardly mobile and in the market for foreign goods.
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However, this isn’t to say that Africa is prosperous. Sixty-one percent of Africa’s 1 billion people
continue to live on less than $2 a day. Vast wealth disparities persist as well. The net worth of 100,000 of
the continent’s richest citizens accounts for 60% of its gross domestic product. A further 180 million peo-
ple can afford to spend only $2 to $4 a day, making them vulnerable to economic shifts that could knock
them out of the middle class. Even those firmly entrenched in the new consumer class are far from rich,
with daily spending budgets between $4 and $20.
To many, the fact that a significant portion of Africa’s population has disposable income at all is
cause for celebration. In fact, some analysts credit this new breed of consumer for buffering Africa
against much of the global financial crisis. Also with jobs on the rise, rural Africans are flocking to cities.
The U.S. ambassador to South Africa even claims that Africa is now nearly as urbanized as China. Again,
all this newfound growth must be viewed alongside current stories of tragedies against citizens in Uganda
and Nigeria as well as the violent repressions in Libya. Still, one can only hope that much of the violence
and chaos that has defined Africa for decades is now in the past, leaving the future open for more political
freedom and economic growth.ii
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TRACKING THE UNDERGROUND ECONOMY
A peculiar statistic has been puzzling economists ever since the economy began its recovery. Re-
tail sales have climbed steadily over the last four years despite the fact that gains in reported income have
stalled. So if people still aren’t getting paid more, where is this disposable cash flow coming from? Ac-
cording to some, one need not look further than the underground economy.
Then again, the sum total of unreported U.S. income isn’t a thing you can easily track on a graph.
All untaxed cash transactions are considered part of the underground economy, including everything from
drug deals to yard sales. Although a definite amount is impossible to determine, most economists value
America’s shadow economy at $2 trillion annually. That accounts for as much as 19 percent of total in-
come, resulting in a yearly tax gap that tops out at $500 billion. Experts fear that disparity will only grow
larger as more and more people become dependent on under-the-table transactions to supplement their
earnings.
Kevin Kalmes, for instance, was out of work for two years when she received a foreclosure notice
on her home. She began to sell items from her basement to raise cash and eventually made enough money
to save the house. Rather than shutter her ad-hoc second-hand shop, though, Kalmes kept her rummage
sale going full-time without permits. Kalmes’ story represents just one among thousands in which people
had to devise their own ways to make money legally in this still shaky economy. Over the long term ex-
perts hope that the current stimulus driven by untaxed cash and enjoyed by retailers will lead to job crea-
tion. Ideally, that would mean fewer people would have to toil in the shadow economy in order to make
their living. Still, there’s a chance that companies could remain reluctant to hire, driving even more peo-
ple to seek out cash through tax-free means. If this turns out to be the case, then the U.S. government may
stand to lose an increasing share of vital tax revenue.iii
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lecture enhancer 2-4
EU NATIONS ADD UNDERGROUND ECONOMIES TO GDP
Even though the U.S. has a gross domestic product (GDP) valued at nearly $17 trillion, that huge
figure still doesn’t come close to providing a complete picture of the American economy. Each year bil-
lions upon billions of transactions go undocumented, untaxed, and ultimately unrecorded by official GDP
statisticians. Whether it’s earning a few bucks by mowing a neighbor’s lawn or by selling drugs, these
concealed deals all form what’s known as the underground economy.
Many economists have said that it’s impossible to determine the true value of the underground economy,
but that’s not getting in the way of some European nations looking for an easy GDP boost. According to
recently implemented EU regulations, the total debt held by a member nation may not exceed 3 percent of
its GDP. As a result, the U.K., Italy, and Ireland are adding illicit activities like drug sales, prostitution,
and even smuggling to their lists of official goods and services. With inflated GDPs, these countries will
be able to take on more debt without facing sanctions from the European community.
Although the EU hasn’t officially commented on this practice, a number of experts have ques-
tioned its merit. After all, criminals usually do their best to hide their earnings. Not only does this make it
difficult to determine their total income, but it also means that their cash is not being taxed. Such mislead-
ing information could potentially make a nation’s GDP less accurate. On the other hand, completely ig-
noring illegal vices distorts the look of an economy by leaving out a big chunk of its output. Nevertheless,
tallying up drug sales isn’t the only way some nations are looking to expand the definition of GDP. The
U.K., for instance, is also revamping the way it measures nonprofit groups. This policy is expected to
boost GDP more than drug sales and prostitution.iv
lecture enhancer 2-5
THE CIRCULAR FLOW MODEL
(PPT 2-21 presents this simplified Circular Flow Model.)
Economists often use models to explain economic principles. A model is like a map of a concept.
A road map shows you the major highways and waterways, not every tree. An economic model presents
an economic concept as a bare-bones “map,” containing only the major elements. Thus a model does not
contain all the detail and complexity of the concept, just the simplified major elements.
One such economic model is the Circular Flow Model, a simplified presentation of the basic
transactions in a free-market economy. The two major elements are consumers (presented in the model as
households) and the businesses that create goods and services.
Each of the factors of production mentioned in the text has a price. To use land, a business must
make rent or mortgage payments (simplified as rent). Labor must be paid salary or wages. The buildings,
equipment, production lines, and so on (capital) are financed by paying interest. Finally, the entrepreneur
expects to earn a profit from using his or her entrepreneurship. However, this resource payment is not
guaranteed. If costs exceed income, the business may suffer a loss. (Some newer versions of this model
include knowledge as a factor of production; older versions usually don’t.)
Businesses demand resources in order to produce products and services. In a capitalist economy,
the households own the factors of production and must be compensated. This income flows back into the
households. The prices of resources are set by the interaction of supply and demand.
The goods and services that households demand are created by business. The consumers in these
households use the income from their factors of production to purchase goods and services.
Chapter 02 - Understanding How Economics Affects Business
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Thus, business activity flows in a circle, which is illustrated by the Circular Flow Model. The
market for resources (top arrows) is known as the resource market. The bottom flow is referred to as the
product market.
This is a simplified model of pure capitalism, and it ignores a major player—government. Pur-
chases of goods and services by all levels of government amount to about 20% of the nation’s gross do-
mestic product. More sophisticated models include the government’s role in diverting resource payments
as taxes and spending on government programs, which creates a more realistic representation of a mixed
economy.
lecture enhancer 2-6
OTHER ECONOMIC INDICATORS
In addition to the key economic indicators mentioned in the text—CPI, GDP, unemployment
rate—other indicators measure different segments of the economy. Below are some of the more important
ones.
KEY ECONOMIC INDICATORS
Producer Price Index Monthly index that measures changes in wholesale prices
Prime Interest Rate Lowest interest rate that banks charge preferred borrowers on
short-term loans
Housing Starts Tracks how many new single-family homes or buildings were
constructed during the month and can detect trends in the econ-
omy looking forward
Durable-Goods Orders New orders for goods that last more than three years
Balance of Trade Total value of a country’s exports minus the total value of its
imports, over a specific period of time
Inflation Rate Percentage increase in prices of goods or services over a period
of time
Consumer Confidence Index Measures the degree of consumer confidence in the economy,
and can indicate an upcoming increase or decrease in economic
activity
THE “BEIGE BOOK”
Many economists use the Federal Reserve Board “Beige Book” to detect trends in the economy.
The correct name for the report is “Summary of Commentary on Current Economic Conditions by Feder-
al Reserve District.” Each Federal Reserve Bank gathers information on current economic conditions in
its district. The Beige Book summarizes this information by district and sector and is a gauge on the
strength of the economy.
TIMING OF THE INDICATORS
Economic indicators can further be classified by the timing of the indicator.
Some indicators are lagging, meaning that they don’t change direction until a few quarters after
the economy does. An example is the unemployment rate. Unemployment tends to increase for two or
three quarters after the economy starts to improve.
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Coincident indicators move at the same time as the economy does. The gross domestic product
measures the economy’s output as it occurs.
Leading economic indicators are indicators that change before the economy changes. Stock mar-
ket returns are a leading indicator, as the stock market usually begins to fall before the economy declines
and they improve before the economy begins to pull out of a recession. Housing starts and the consumer
confidence index are other leading economic indicators.v
lecture enhancer 2-7
HOW ACCURATE IS THE GDP?
In today’s modern economy, statistics are supreme. GDP, unemployment and interest rates all
play dominant roles in the allocation of the government’s budget. No spending bill can hope to pass into
law without a battery of statistics and figures charting how such legislation will benefit the country. But
just how accurately do those numbers reflect the world we live in?
Take GDP, for instance. The famous figure has only been reliably collected in the U.S. since the
1930s and didn’t become the primary indicator of the nation’s economic health until 1991. Yet despite
such a short history, economists and legislators treat GDPs of any stripe with devotion. For instance,
global financial markets recently went into uproar when China reported its GDP at 7.7 percent rather than
the expected 8 percent. That missing 0.3 percent may seem negligible, but it was enough to ruffle the
feathers of analysts across the world who now had to readjust their projections. But if the accuracy of the
U.S.’s GDP is merely suspect, China’s is outright unreliable. Only gathered for less than 20 years, the
Chinese GDP fails to account for many key factors, such as the political pressure of its five-year plans or
the enormous private loan industry.
Other figures present similar problems. In trade stat terms, every time an iPhone leaves a Chinese
factory and lands on American shores, $200 is added to our trade deficit with China. In reality, though,
the components of that same iPhone have been produced all over the world, not just China. A more accu-
rate figure would take all those other manufacturers into account and ascribe value accordingly. Instead,
current guidelines grant sole credit to the country where the product is “assembled.” Ultimately, statistical
hiccups like this demonstrate just how much the world has changed since these figures became prominent.
Decades ago, it was safe to assume that a product was fully assembled in one place. That is simply not the
case today as complex supply chains send items crisscrossing around the world. So while statistics like
these no doubt provide relevant information, the conclusions they reach are perhaps not so concrete as to
justify basing entire economies around their slight shifts in value.vi
lecture enhancer 2-8
HONDA BECOMES AN AMERICAN EXPORTER
The slow reemergence of American manufacturing has been touted by politicians on both sides of
the aisle as an essential force in the recent economic recovery. But in many cases, the manufacturers driv-
ing production across the nation aren’t American at all. In fact, Honda recently announced that it built and
shipped more cars from the U.S. than it imported here from Japan.
According to Honda executives, the company’s current status as an American exporting power
wasn’t the intention when it set up shop on these shores 30 years ago. “We did not set out to be a net ex-
porter,” says Rich Schostek, senior vice president of Honda North America. “What we did set out to do
was become self-reliant in North America.” Just as General Motors has invested heavily in China, Honda
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adapted a “produce-where-you-sell” model as it expanded operations throughout the country. Last year,
Honda’s 10 U.S. plants, staffed by approximately 28,000 American workers, produced 1.3 million cars,
most of which were sold domestically. However, more than 100,000 vehicles were exported to develop-
ing markets throughout the world, a number that eclipsed the 88,500 cars imported by the U.S. from Ja-
pan.
To some, including President Obama, Honda serves as a prime example of a foreign company
providing jobs rather than taking them away. But critics on both the right and left are worried companies
like Honda are an exception rather than the rule and that American jobs could be at stake if foreign trade
is encouraged any further. Then again, the state of industry in this country has been troubled for some
time, and any capable job creator could be beneficial, regardless of their country of origin.vii
lecture enhancer 2-9
WHAT IS A DEPRESSION?
In 2009 with the stock market falling, banks failing, and unemployment soaring, many people
wondered if the U.S. economy was suffering not from a recession, but from a much worse condition, a
depression. Economists say that a depression is, well, nobody really has a formal description for a depres-
sion. A depression is when things are really, really bad.
While recessions are easy to define, there are no firm rules for what makes a depression. Every-
one at least seems to agree there hasn’t been one since the epic hardship of the 1930s. According to econ-
omist Peter Morici, a business professor at the University of Maryland, you’ll know you’ve been in a re-
cession when you see it behind you. “It’s not going to be acknowledged until years go by.”
No one disputes the definition of a recession, and the economic downturn of 2008–2010 surely
qualified. Recessions have two handy definitions—two straight quarters of economic contraction, or when
the National Bureau of Economic Research makes the call.
Declaring a depression is much trickier.
• By one definition, it is a downturn of three years or more with a 10% drop in economic
output and unemployment above 10%.
• Another definition says a depression is a sustained recession during which the populace
has to dispose of tangible assets to pay for everyday living.
• Morici says a depression is a recession that “does not self-correct” because of fundamen-
tal structural problems in the economy, such as broken banks or a huge trade deficit.
• Or maybe a depression is whatever corporate America says it is.
The Great Depression still maintains top ranking. Unemployment peaked at more than 25%.
From 1929 to 1933, the economy shrank 27%. The stock market lost 90% of its value from boom to bust.
The 2008–2010 recession came nowhere near those figures. And government policy makers argue that
safeguards in place today weren’t there in the 1930s: deposit insurance, unemployment insurance, and an
ability by government to hurl trillions of dollars at the problem.
Before the 1930s, any serious economic downturn was called a depression or a panic. The term
recession didn’t come into common use until depression became burdened by memories of the 1930s.
When the economy collapsed again in 1937, people didn’t want to call that a new depression, and that’s
when the term recession was first used. According to Millsaps College professor Robert McElvaine,
“People also use ‘downward blip.’ Alan Greenspan once called it a ‘sideways waffle’.”viii
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Government officials are extremely cautious in using the D-word. Alfred Kahn, a top economic
advisor to President Carter, learned that lesson in 1978 when he warned that rampaging inflation might
lead to a recession or even “deep depression.” When presidential aides asked him to use another term,
Kahn promised he’d come up with something completely different.
“We’re in danger,” he said, “of having the worst banana in 45 years.”
