Capitalist (Price System) economies experience business cycles. Over the past 50
ID: 1195230 • Letter: C
Question
Capitalist (Price System) economies experience business cycles. Over the past 50 or so years governments have been able to moderate these business cycles and keep price instability and unemployment at a minimum relative to the 1800s and early 1900s. There are two policy methods that the government can use: fiscal (Treasury Dept. and Congress) and monetary (Federal Reserve). How do these two policy methods work, what are the differences between them and which one is more effective at controlling price instability and unemployment? Your answer should include why there is a need for government intervention in the first place (i.e. if the markets are self-correcting in reality there should be no need for government help), the two types of inflation/deflation, the Equation of Exchange (you should also identify and explain which type of inflation is persistent in the actual economy), the process (meaning what steps are involved if any and how money gets into the hands of consumers and firms) of both policies and the theories behind them (inflation targeting, Taylor rule, fine-tuning vs. policy rules, Monetary Consensus, demand-driven economy, Monetarism, supply-driven economy, etc.). Capitalist (Price System) economies experience business cycles. Over the past 50 or so years governments have been able to moderate these business cycles and keep price instability and unemployment at a minimum relative to the 1800s and early 1900s. There are two policy methods that the government can use: fiscal (Treasury Dept. and Congress) and monetary (Federal Reserve). How do these two policy methods work, what are the differences between them and which one is more effective at controlling price instability and unemployment? Your answer should include why there is a need for government intervention in the first place (i.e. if the markets are self-correcting in reality there should be no need for government help), the two types of inflation/deflation, the Equation of Exchange (you should also identify and explain which type of inflation is persistent in the actual economy), the process (meaning what steps are involved if any and how money gets into the hands of consumers and firms) of both policies and the theories behind them (inflation targeting, Taylor rule, fine-tuning vs. policy rules, Monetary Consensus, demand-driven economy, Monetarism, supply-driven economy, etc.).Explanation / Answer
Business cycle refers to the period that includes economic boom followed by contraction of economy. It results due to the downward and upward movement of GDP. Government intervention is very crucial for the capitalist economies to realize the benefits of market capitalism and simultaneously reducing the illegal and unethical business practices of fraud, cheat, and tendency to cut corners. Government intervention is crucial to protect the labors against unfair wages.
Inflation refers to the increase in prices of goods/ services over a time period. The inflation is divided into two parts- demand-pull inflation in which the excess of demand over supply results in increase of prices and cost-push inflation in which price level increases due to rising input cost. Deflation is the inverse of inflation meaning decline in general price levels. The cost-push inflation is more persistent in the actual economy due to continuously changing input costs like labor cost, raw material cost an taxes.
To manage the inflation/deflation in market government use two types of tools namely fiscal and monetary policy. Monetary policy manages the economy by varying the circulation of interest rate and money supply in the market. It is majorly done with the help of Federal Reserve. Fiscal policy uses taxing and spending action of governments.
Money supply has very huge impact on the economic activities. Putting more money in the customer’s hands through reduced interest rates, government stimulates higher purchasing. Thus, sales of the firms would increase. In turn, the labor demand will increase in the market. It ultimately leads to rise in price of goods/services. Now, public will face inflation, simultaneously the lenders would increase the interest rates. It would reduce the purchasing power of consumers. Hence money flows in an economy. Hence, theory of demand-driven and supply-driven economy plays crucial role in the capitalist economies.
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