Economics Articles

Cheat Sheet / Updated 09-05-2023

People have to make choices because of scarcity, the fact that they don’t have enough resources to satisfy all their wants. Economics studies how people allocate resources among alternative uses. Macroeconomics studies national economies, and microeconomics studies the behavior of individual people and individual firms. Economists assume that people work toward maximizing their utility, or happiness, and firms act to maximize profits.

Article / Updated 12-14-2022

The worldwide Great Recession of 2007 to 2009 began in the economy when a housing bubble in the United States popped in 2006. Trillions of dollars had been invested in the financial markets on the premise that residential housing prices would never decline significantly. As the bubble burst and home prices began to plummet, the economy took a hit as dozens of large banks as well as many hundreds of financial firms were threatened with bankruptcy. Lending ceased not only for home mortgages but for business loans, and if it hadn’t been for aggressive interventions by governments and central banks, the entire worldwide financial system might have collapsed, such that nobody would have been able to obtain a loan for any purpose. Because the world economy is highly dependent on borrowed money to finance everything from credit card purchases to factory construction, another Great Depression loomed just over the horizon. The Fed and other central banks to the rescue To calm the immediate crisis, the Fed and other central banks became lenders of last resort, ensuring that businesses could still obtain financing directly from the Fed even if banks were reluctant to loan. The Fed also protected banks from banking panics by increasing the insurance limits offered to checking account depositors. These and other steps limited the recession to only being moderately severe. Yet, the Great Recession was still much more severe than your typical recession. So it wasn’t surprising that the Fed and other central banks undertook innovative new monetary policy measures to stimulate the economy. These came to be known as unconventional monetary policy. Under conventional monetary policy, central banks like the Fed use open-market operations to purchase short-term (less than 1-year maturity) government bonds to increase the money supply and drive short-term interest rates toward zero in order to stimulate the economy. A strategy known as quantitative easing But given the severity of the Great Recession, the Fed and other central banks found that conventional monetary policy wasn’t going to be enough to drive short-term interest rates to zero. Additional stimulus was needed. So the Fed and other central banks began to purchase trillions of dollars worth of longer-term government bonds (with 5-year, 10-year, and 20-year maturities), private-sector bonds (including mortgage-backed securities), and even stocks. The goal in all cases was to increase the quantity of money available to be loaned out. It was hoped that more borrowing and lending would take place, thereby stimulating both consumption and investment. These policies became known as quantitative easing (or QE), since their goal was to ease the constraints on lending and borrowing by increasing the quantity of money in circulation. By contrast, conventional monetary policy targets not the quantity of money in circulation but rather the price of money — the interest rate. Conventional monetary policy attempts to simulate the economy by lowering the price of loans. Unconventional monetary policy (quantitative easing) attempts to increase the sheer volume of loans. Setting a target for inflation Another unconventional monetary policy was setting an explicit target for inflation, so that people would know how aggressive central banks were going to be with changes in the money supply. The inflation target was set at 2 percent in the United States, which could only be met if the Fed were increasing the money supply faster than any increase in money demand. By setting a 2 percent target, the Fed was committing itself to continually pushing the AD curve to the right and thus always attempting to stimulate the economy. This commitment was intended to give consumers and businesses confidence that the Fed would stimulate as long as necessary until the Great Recession was over and the economy had fully recovered.

Article / Updated 12-13-2022

Over the last 50 years, the U.S. economy has grown at an average annual rate of about 2.8 percent. Roughly 1.1 percent has come from population growth: the country typically adds more workers each year. But the majority of it comes from the fact that it gets more productive each year — to the tune of about 1.7 percent annually. If this progress had been steady and even, macroeconomists could just focus on the long-run growth questions. But, like true love, the course of gross domestic product (GDP) seldom runs smoothly. The Great Recession of 2007–09 was a reminder that the economy often wanders far from the long-run trend, with GDP falling and unemployment rising. The GDP that those unemployed workers could have produced — such as more or better health care, more or better transportation services, more or better education, or a lot of other stuff that society values — is lost. To be sure, given how unemployment is measured, some people are unemployed even in the best of times. Basically, you're considered to be unemployed if: a) you don't have a job, and b) you've been looking for one in the last few weeks. Yet over any month or quarter, some people lose or quit their jobs and look for new ones. Others, either new young workers or older ones who had been happy taking time off, enter the labor force and search for employment as well. Because it takes time to match each worker with a specific skill set to a firm looking for just those skills, these workers clearly meet the definition of being unemployed. Because such unemployment reflects the normal frictions in the job matching process, economists refer to it as frictional unemployment. In addition, there are structural features of the labor market that also lead to positive unemployment even in overall good economic times, what economists call structural unemployment. Regulations, for example, that make it difficult to discharge workers once they are employed are also likely to make companies reluctant to hire workers in the first place. State licensing policies and regulations can have a similar effect. It may surprise you to learn that virtually every state imposes a licensing requirement not only for professional occupations like doctors, dentists, and lawyers, but also for those such as manicurists, cosmetologists, HVAC contractors, and massage therapists. Some even impose requirements for being an upholsterer, a locksmith, or an interior designer. Often there is little reciprocity between states. So, in moving from one state to another, a worker frequently must repeat many of the exams and training necessary to regain her license. This expense can be enough to wipe out any gain from moving to a different state. Even if there is a surplus of, say, medical technicians in New Mexico and a shortage in California, those in New Mexico may choose to stay unemployed rather than move to California and incur the cost of regaining a license. Recent estimates suggest that such licensure requirements cost up to nearly 3 million jobs per year. Minimum wage laws can also cause structural unemployment. By mandating a wage higher than the market would, such laws can attract a lot of workers while at that same time making companies less willing to hire. The excess supply will again be considered unemployed — not because there are no jobs but because they cannot get employed by offering to work for a lower wage. The law prevents that. To be sure, this view has been challenged in recent years as economists have found that such effects may be countered by the fact that a higher wage makes it easier to hire and keep workers, thereby paying for itself in lower turnover costs. But part of the reason for this is that, within the U.S., the current federal minimum wage is so low. In inflation-adjusted terms, the current federal minimum wage of $7.25 per hour would have to be about $9 to reach the peak reached in the late 1960s. At such low levels, it is perhaps quite plausible that even significant increases to, say, $12 or $15 an hour might still not create any unemployment. However, at some point, the traditional argument surely holds. Mandating a minimum wage of $30 an hour, for example, would definitely price large numbers of workers out of their jobs. In the case of both frictional and structural unemployment, any solutions lie mainly in policies to improve the functioning of the labor market, that is, in microeconomic policies. These might include improving the information that workers and firms have about each other and reforming licensure practices. By contrast, cyclical unemployment reflects more purely macroeconomic forces. It is, as its name implies, a short-run phenomenon associated with the business cycle. It usually stems from low demand for goods and services that leads firms to cut production and lay off workers. Those workers want jobs and are willing to work — there just aren't enough jobs available to employ them. Cyclical unemployment is very costly because it means not using resources to produce goods that the economy would produce if it were operating normally. The U.S. Congressional Budget Office estimates that in 2009 the U.S. economy lost about $1 trillion (nearly 7 percent) of GDP due to the unemployment associated with the recession. That's a whole lot of healthcare, automobiles, education services, or whatever we wanted to use those unemployed resources to make. This is why understanding the reason that the economy periodically falls into recession is the second great macroeconomics question. The payoff to reducing the costs of cyclical unemployment is potentially very large.

Cheat Sheet / Updated 09-20-2022

Forecasting what will happen in the economic future is hard. Nobody gets it right all the time. However, with a grounding in economic indicators, you can improve your investment results and the profitability of your business.

Cheat Sheet / Updated 04-05-2022

Behavioral economics is about bringing reality into economic analysis. It borrows from psychology, sociology, politics, and institutional economics (which focuses on the rules of the economic game) to describe and explain human behavior and economic phenomena. Behavioral economics builds upon conventional economics, offering more tools for understanding why people behave the way they do when it comes to income, wealth, ethics, and fairness. It uses prospect theory to describe the choices that the typical person makes.

Cheat Sheet / Updated 03-22-2022

Macroeconomics is the study of the economy as a whole. What follows are summaries of some key information about how the economy works, including the basics of fiscal and monetary policy, the key summary statistics that macroeconomists examine in order to assess the health of an economy, and how the economy behaves in the short- and long-term.

Cheat Sheet / Updated 02-28-2022

Microeconomics is that part of economics that looks at the world from the perspective of consumers and firms — asking how they make their decisions and how those decisions come together to make different kinds of markets. You do that by building models of different situations that explore the results of different types of conditions.

Cheat Sheet / Updated 02-25-2022

Markets rely on participants engaging in mutually beneficial exchange. If participants are free to choose, they trade only if they perceive a personal gain. Thus, the consumer buys the goods and services that give them the most satisfaction relative to the price they pay, while businesses sell the goods and services that generate the most or maximum profit. Managerial economics develops business strategies that maximize profit.

Cheat Sheet / Updated 02-23-2022

Economics is the science that studies how people and societies make decisions that allow them to get the most out of their limited resources. Because every country, every business, and every person deals with constraints and limitations, economics is literally everywhere. This Cheat Sheet gives you some of the essential information about economics.

Cheat Sheet / Updated 02-09-2022

You can use the statistical tools of econometrics along with economic theory to test hypotheses of economic theories, explain economic phenomena, and derive precise quantitative estimates of the relationship between economic variables. To accurately perform these tasks, you need econometric model-building skills, quality data, and appropriate estimation strategies. And both economic and statistical assumptions are important when using econometrics to estimate models.