Preliminary Economic Concepts and Principles:



American Experience from 1920’s through the 1970’s:(“The Commanding Heights” – Chapter 2)(“Economics” – Chapter 14)(“Economics” – Chapter 16)(“Economics” – Chapter 7, pages 117–122)Very strong economic performance during the 1920’s (i.e., the “Roaring Twenties”):Low unemployment; inflation near 0% throughout decade; tremendous increases in per capita GDPTrend toward “modernization” and “urbanization”: rapid increase in households with electricity, radio ownership, automobile ownershipPartly fueled by the Mellon-Coolidge-Harding tax cuts of the 1920’s: Revenue Acts of 1921, 1924, & 1926Andrew Mellon, Secretary of the Treasury of the U.S. from 3/1921 to 2/1932Warren Harding, President from 3/1921 to 8/1923Calvin Coolidge, President from 8/1923 to 3/1929Year:Highest MTR:Lowest MTR:191767%2%191877%6%1919–192173%4%1922–192358%4%192446%2%1925–193125%1.5%Tax revenues increased from $700 million in 1921 to over $1 billion in 1928 and 1929During Pres. Coolidge’s time in office, unemployment averaged 3.3% and inflation averaged 1% => lowest Misery Index of any 20th Century PresidentBut, one group that did not prosper during the 1920’s was the American farmer…Agricultural productivity and output were rising during the 1920’s => prices for many commodities falling; society needed fewer people to be farmers (each farm could feed more people); profits of farmers fell => steady increase in farm foreclosure ratesMany, including President Herbert Hoover (in office from 3/1929 to 3/1932) were calling for increased tariffs to protect farmers from foreign competitionRecall that economists are generally opposed to trade restrictions [94.1% agree that “tariffs and import quotas usually reduce the general welfare of society”]Recent (2002) study by the Federal Reserve Bank of Dallas, focusing on the costs to society of saving a job by imposing trade restrictions…JobsAnnual CostIndustrySavedper Job SavedBenzenoid Chemicals216$1,376,435Softwood Lumber605$1,044,271Sugar2,261$826,104Dairy Products2,378$685,323Machine Tools1,556$479,452Canned Tuna390$257,640Peanuts397$187,223Women’s Footwear3,702$139,800…clearly, trade restrictions are not the most cost effective way to help workers in these industries…Smoot-Hawley Tariff Act of 1930:Debated throughout 1929 => would ultimately cover many non-agricultural industries as wellWhile being debated, many trading partners imposed preemptive, retaliatory tariffs against the U.S.In May 1930, 1,028 economists sent a letter to President Hoover asking him to not sign the billSigned into law on June 30, 1930 => the most protectionist legislation in U.S. history => virtually closed the borders to foreign goods and ignited a vicious international trade war [over 25 countries retaliated with trade restrictions within the next two years]Consumption goods imported from abroad now cost more for U.S. consumersFactors of production imported from abroad now cost more for U.S. producers [more than 800 items used in automobile production were taxed by Smoot-Hawley]Between 1929 and 1933: U.S. exports fell from $5.4 billion to $2.1 billion [61% decrease] and U.S. imports fell from $4.4 billion to $1.5 billion [66% decrease]Contractionary Monetary Policy:Federal Reserve started raising interest rates (thereby decreasing the money supply) in the late 1920’s => between August 1929 and March 1933, nation’s money supply was decreased by one-thirdStock Market Crash of 1929 caused in part by the debate of Smoot-Hawley (strong correlation between changes in value of stock market and debates in Congress on Smoot-Hawley throughout 1929) and the contractionary monetary policy which began in 1929…Stock Market Crash of 1929: (9/3/1929 to 11/13/1929)Stock market trends during 1920’s…Dow Jones Industrial Average increased from 63.9 in mid-1921 to 381.17 on September 3, 1929 (increase of roughly 500% over eight years)But, much of this increase was an “artificial increase in prices” and did not reflect increases in the “true, underlying value of the firm.”A great deal of uninformed investment in “new technologies”Making purchases “on margin” (borrowing money to buy stock – brokers lending buyers up to two thirds of purchase price) was a common practice at this timePurchasing “on margin” did not cause the crash, but it made a bad situation even worse……if you own $1,000 worth of stock and it becomes completely worthless, that’s bad…but it’s even worse if you borrowed $750 to buy the stock (you’re left with worthless shares and a $750 debt)Dow Jones Industrial Average (DJIA) – stock market index created by Wall Street Journal Editor Charles Dow in 1896, to gauge the performance of the industrial sector of the U.S. stock market“Weighted average” of stock prices of 30 large and widely held publicly traded companies in the U.S.Currently consists of companies such as: 3M, AT&T, Boeing, Coca-Cola, ExxonMobil, General Electric, Travelers Insurance, Home Depot, McDonald’s, Microsoft, Pfizer, Walmart, and Walt DisneyU.S. Stock Market Crash of 1929: Black Thursday (10/24/1929): record 12.9 million shares tradedMonday, 10/28/1929: DJIA lost 12.8% of valueBlack Tuesday (10/29/1929): DJIA lost 11.7% of value9/3/1929 to 11/13/1929, DJIA went from 381.17 to 198.69 (loss of 47.87%)Triggered a “worldwide financial crisis” => collapse of banking and financial systems around the globeAdditional “Crashes” throughout the Great DepressionCrash of 1930-1932: from 4/17/1930 to 7/8/1932, the DJIA fell from 294.07 to 41.22 (loss of 85.98%)Crash of 1937-1938: from 3/10/1937 to 3/31/1938, the DJIA fell from 194.40 to 98.95 (loss of 49.10%)Crash of 1939-1942: from 9/12/1939 to 4/28/1942, the DJIA fell from 155.92 to 92.92 (loss of 40.41%)From 9/3/1929 to 7/8/1932 the DJIA went from a value of 381.17 to 41.22 (loss of 89.19%)Other Significant Declines since Great Depression:Late Aughts: 53.78% decline from 10/9/07 to 3/9/09Internet “Tech Bubble” and 9/11/2001: 38.22% decline from 1/15/00 to 10/9/021987 “Black Monday” (10/19/1987): 36.13% decline from 8/25/1987 to 10/19/1987Early 1970’s (Watergate): 45.08% decline from 1/11/1973 to 12/6/1974Late 1960’s: peak of 985.21 on 12/3/1968; low of 631.16 on 5/6/1970 (loss of 35.94%) INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET The two primary causes of the Great Depression were protectionist trade policies (e.g., Smoot-Hawley Act of 1930) and contractionary monetary policy…Stock Market Crash of 1929 was not a cause of – but was rather a symptom of – the Great Depression. But, in part because of the practice of purchases made “on margin,” the crash would worsen the downturn.Further, increased rates of taxation and increased government involvement in the economy throughout the 1930’s would prolong the downturnArthur Laffer, Stephen Moore, and Peter Tanous (in “The End of Prosperity”):“The twelve-year economic slide was a result of trade protectionism, high tax rates, a contractionary monetary policy, and a New Deal mishmash of government programs that were well intentioned, but made things worse, not better.”Lawrence Reed (in “Great Myths of the Great Depression”):“The genesis of the Great Depression lay in the irresponsible monetary and fiscal policies of the U.S. government in the late 1920’s and early 1930’s. These policies included a litany of political missteps: central bank mismanagement, trade-crushing tariffs, incentive-sapping taxes, mind numbing controls on production and competition…”Historic Magnitude of Great Depression…Previously noted 89.19% decline in value of DJIA between 9/3/1929 and 7/8/1932 (along with subsequent crashes in late 1930’s and early 1940’s)Unemployment Rates during the Great DepressionSince 1900, the rate has never been above 10%, except for the period from 1931 to 1940, during which time it was above 10% for 10 straight years!Recall, in 2011 the unemployment rate was 8.95%, which was only the sixth year since World War II in which a rate above 8% was realized (8.48% in 1975, 9.71% in 1982, 9.60% in 1983, 9.26% in 2009, 9.63% in 2010) => above 8% for 12 straight years from 1930 through 1941YearPopulationLaborForceUnemployedUnemployment Rate192988,010,00049,440,0001,550,0003.14%193089,550,00050,080,0004,340,0008.67%193190,710,00050,680,0008,020,00015.82%193291,810,00051,250,00012,060,00023.53%193392,950,00051,840,00012,830,00024.75%193494,190,00052,490,00011,340,00021.60%193595,460,00053,140,00010,610,00019.97%193696,700,00053,740,0009,030,00016.80%193797,870,00054,320,0007,700,00014.18%193899,120,00054,950,00010,390,00018.91%1939100,360,00055,600,0009,480,00017.05%1940101,560,00056,180,0008,120,00014.45%1941102,700,00057,530,0005,560,0009.66%Annual GDP Growth Rates in the United States (over the 82 year period from 1930 to 2011):Mean value of 3.36%; median value of 3.45%Negative value in only 17 of 82 yearsSince Great Depression, only three instances of “consecutive years of negative growth”:2008/2009: –0.3% and –3.1% respectively1974/1975: –0.6% and –0.2% respectively1945/1946/1947: –1.1%, –10.9%, and –0.9% respectivelyNegative growth rates during Great Depression of:1930 = –8.6%1931 = –6.5%1932 = –13.1%[lowest rate since 1930]1933 = –1.3%[4th straight year of negative rate]…1938 = –3.4%Rate of “–3.0% or lower” in only 6 years since 1930, and 3 of these 6 were consecutive years from 1930 through 1932The Great Depression was much more severe and much longer lasting than any other economic downturn either before or since…Following the start of this worldwide Great Depression, totalitarian dictatorships emerged in Germany (Adolf Hitler), Italy (Benito Mussolini), and Japannot clear that “democratic capitalism” would survive in the U.S. (especially when the role of the Federal government and powers of the executive branch were greatly expanded under FDR)August 1936: Gallup poll asked “Do you believe the acts and policies of the Roosevelt Administration may lead to Dictatorship?”Hard to believe that such a question was even askedOverall, 45% said “yes”There were 10 states in which over 50% said “yes”At the time, the belief was that the Great Depression was caused by the inherent instability of markets and that government intervention was needed to stabilize the economyExpansion of Government Begun by Hoover:Herbert Hoover (President from 3/1929 to 3/1933) was in office during the start of the Great Depression and the Stock Market Crash of 1929in an effort to minimize the economic downturn, President Hoover expanded the role of the Federal government in the economyTrend toward increased government would continue under Franklin Delano Roosevelt (President from 3/1933 to 4/1945) who implemented the “New Deal”“New Deal” – title given by FDR to programs initiated between 1933 and 1938 with the goal of providing “relief, recovery, and reform” during the Great Depression; consisted of a wide variety of programs, including:the National Recovery Administration;increased regulation of markets;the Agricultural Adjustment Acts;the creation of Social Security; andattempted stimulus via Keynesian Fiscal Policy;Rex Tugwell (a member of FDR’s “Brain Trust” and one of the people who was influential in formulating many of the ideas for the New Deal) stated, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.”(i)National Recovery Administration (NRA)NRA created on June 16, 1933 (by the National Industrial Recovery Act) sought to “get labor, business, and government to cooperate in a grand partnership” => headed by Hugh “Iron Pants” JohnsonFDR’s call for a “partnership in planning between government and business…(with) government having the right to prevent…unfair practices…by authority.” => essentially an attempt at “Indicative Planning”NRA allowed industry leaders to create “codes of fair competition” – intended to reduce “destructive competition between firms” by setting minimum wages, maximum weekly hours worked, prices that firms could charge, and other restrictions on the behavior of business => legally established collusionEven businesses that were not directly involved in writing the codes were subject to the codesMore than 540 NRA codes covered over 2 million employers who hired over 22 million workersMore than 50% of all workers in the U.S. were employed by firms subject to NRA codesNRA codes led to an estimated increased cost of doing business of roughly 40%John Maynard Keynes stated that the NRA “probably impedes recovery”; Yale economist Irving Fisher told FDR that “the NRA has retarded recovery and especially [has] retarded re-employment.”Declared Unconstitutional by Supreme Court in 1935 (by a unanimous 9 to 0 decision) => industrial production significantly increased only after the NRA was abolishedMethods of getting people to comply with NRA codes:The “Blue Eagle” (with the motto “We Do Our Part”) was the patriotic symbol of compliance that companies were expected to hang on their doors => people urged to boycott non-participating businesses INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET New professional football team named in honor of the “Blue Eagle” => Philadelphia Eagles (which helps explain the hideous powder blue retro uniforms) INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET Staging of military style parades and mass rallieson 9/12/1933 the largest parade in the history of NYC was staged in support of the NRA: nearly a quarter million people marched for 10 hours with 49 military planes flying overhead => a member of the British Labor Party in attendance was horrified, saying it reminded him of Nazi GermanyIndoctrination of schoolchildren: 100,000 kids marched into Boston Common and led to swear an oath, administered by the mayor: “I promise as a good American citizen to do my part for the NRA. I will buy only where the Blue Eagle flies.”Withholding of Government Contracts: Henry Ford refused to sign off on the NRA codes (which had been drafted and signed by GM, Chrysler, and others)Ford would not receive any government contracts unless they agreed to the code => Ford submitted a bid to build 500 trucks for the Civilian Conservation Corps for $169,000 below the next best offer, but was not given the contractThreats/Imposition of Fines/Imprisonment: people were fined or jailed for not complying with NRA codes (or altered behavior to avoid such punishments)R.W. Johnson of Meridian, MS operated a dry cleaning service on the outskirts of town: to avoid being fined, he charged the higher NRA prices and lost customersArmand Friedlander of Houston, TX operated a jewelry store: under NRA codes, he was not allowed to advertise prices for repairing watchesSam and Rose Markowitz of Cleveland, OH and Jacob Maged of Jersey City, NJ operated dry cleaning servicesMarkowitz’s fined $15 each for charging 5? less than the NRA code price for cleaning suits => refused to pay the fines and were thrown in jailMaged fined $100 and spent 3 months in jail for charging 35? to press a suit, instead of the 40? dictated by NRA codeFinal note on NRA: as is often the case when government regulations are imposed, many NRA codes raised new issues which had to be addressed…In some instances, businesses in small towns were exempt from complying with the NRA codes… Should a business be allowed to move to a small town to avoid the restrictions of the NRA code?In some industries the mandated wage rate was lower for women than for men… Should a business be allowed to fire men and replace them with women in order to reduce labor costs?(ii)Increased Regulation of Marketsprevailing view at the time was that the Great Depression was caused largely by the instability of markets and businesses’ unfettered quest for profit => large part of the New Deal focused on the “Regulation of Markets”Regulation of Markets – government policies intended to directly alter market outcomes, often with the intention of influencing the number and size of firms in an industry, wages paid to workers, working conditions, types of products produced, etc.Regulation of Markets by the Federal Government did not begin under the New Deal…Interstate Commerce Commission (ICC) – Federal agency created in 1887 to regulate the behavior of railroads; regulation in the U.S. began with the creation of the ICC…but, Federal Government regulation of Markets was greatly expanded/accelerated as part of the New DealAgencies/regulations created under the New Deal includedFederal Communications Commission (FCC – 1934) – regulates all non-Federal Government use of the radio spectrum, all interstate communications, and international communications to/from U.S.Civil Aeronautics Authority (CAA – 1938) – regulated all non-military aviation in U.S., including fares and service routes of private airlinesNational Labor Relations Board (NLRB – 1935) – agency created to conduct elections for labor union representation and to investigate unfair labor practicesSecurities and Exchange Commission (SEC – 1934) – created in response to Stock Market Crash of 1929, in order to regulate and restore efficiency to financial markets (in part by creating financial disclosure requirements for publically traded firms)Federal Minimum Wage – attempted implementation by FDR in 1933 (declared Unconstitutional by Supreme Court in 1935); established by the passage of the “Fair Labor Standards Act of 1938” (25? per hour => $3.77 in 2009 dollars)(iii)Agricultural Adjustment Acts of 1933 and 1938prices of agricultural output declined by more than 50% between 1929 and 1933 (but over this short time there was not a huge decrease in the number of farmers) => per capita income of farmers dramatically decreasedprompted government to directly intervene in agricultural markets in an attempt to artificially inflate prices and wagesgovernment: bought crops and removed the food from markets; paid farmers not to grow crops (i.e., took land out of farming); imposed restrictions on output levelsin total, policies introduced many inefficiencies into agricultural markets and prevented a long run efficient reallocation of productive resources(iv)Creation of Social Security the Social Security Act of 1935 established the Social Security Systemat the onset, it established aprogram to provide income for old age and disabled individuals (and dependents)federal role in funding programs of unemployment compensationfor the first time, the federal government in the U.S. was playing a role in providing a “safety net”(v) Large scale use of Keynesian Fiscal Policy to “replace missing private spending with government spending”a major component of the New Deal consisted of attempts to put the unemployed back to work through government “make-work” programsthese attempts were begun under Pres. Hoover with the passage of the “Emergency Relief and Construction Act of 1932”continued and expanded under FDR: Civil Works Administration (1933 and 1934) and the Works Progress Administration (1935 to 1943)government: hired workers to construct or renovate buildings, bridges, highways, schools, parks; funded arts and literacy projects; funded programs to provide food, clothing, and housing to those in needWPA was the largest employer in the U.S. from 1935 to 1943Criticisms of public works projects:even if they provided short term relief, programs would inefficiently divert valuable resources to economically counterproductive or politically motivated purposes in the medium and long termfunding for WPA projects often based upon political motives (i.e., given as a return for legislator political support or in an attempt to influence voting behavior of workers)even with unemployment above 20%, many claim that the government policies diverted resources away from or prevented resources from flowing to private sector uses:Walsh-Healey Act of 1936 fixed standards for hours, wages, and working conditions for government employment at artificially desirable levels => indirectly prevented private firms from being able to hire with “less desirable offers” => this kept private sector unemployment artificially high“Crowding out” – on Page 249 of the Economics textbook it is noted that many of these programs “…were merely substitutes for normal private-sector activity that now did not occur because, in part at least, of the reforms themselves.”Finally, how effective were these efforts if the Unemployment Rate was still above 14% in 1940 (9 years after the start of such programs)?Under Hoover and FDR the federal government also played a larger role by way of imposing high taxes…Increased Federal Income Taxes: Federal Income Taxes dramatically increased by Hoover (reversing the Mellon-Coolidge-Harding tax cuts) and FDRYear:Highest MTR:Lowest MTR:1925–193125%1.5%1932–193563%4%1936–194079%4%194181%10%1942–194388%19%1944–194594%23%Revenue Act of 1932 (signed by Hoover): largest tax increase in peacetime history, essentially doubled the income tax => further increases by FDRIn July 1941 FDR suggested increasing the MTR on income over $100,000 to 99.5%; FDR justified it to his budget director by saying, “Why not? None of us is ever going to make $100,000 a year.”On 4/27/1942 FDR signed an Executive Order (rescinded by Congress) which would have taxed all income over $25,000 at a MTR of 100%Increased Excise Taxes: when Income Tax Revenue decreased at the start of the Great Depression, President Hoover tried to offset this loss of revenue by imposing a wide array of per unit taxes on a wide array of goods including: cars, movie tickets, radios, long distance phone calls, telegrams, cosmetics, cameras, yachts, and gasoline.Many of these taxes were regressive (since people with low incomes tend to spend a larger fraction of their income)if a husband and wife each smoked a pack of cigarettes a day, they would pay $43.80 per year in taxes (about 5% of a typical family’s income)Also recall, the incidence of the tax is essentially “hidden” from consumersCongressman Francis Maloney commented “if the family were sent a bill for $10 and were told it was for cigarette taxes, there would be a tax rebellion.”Excise taxes were largely kept in place or increased under FDR (e.g., in 1933 FDR increased the gas tax from 1.0? to 1.5?)Long Term Impact of the “New Deal” on U.S. Economy => acceptance of larger government and Keynesianism:In response to the Great Depression the U.S.embraced regulation and government intervention in the economy…accepted the notion of using Keynesian Fiscal Policy to smooth macroeconomic activity……but did not become a “planned economy” like many European countries.Ideas of Keynes quickly gained supporters in Washington, in large part because the recommended fiscal policies provided a way for government control of the economy that was not as “statist” or “intrusive” as the policies implemented throughout Europe.Post WW-II Economic Performance of U.S.:the only country to come out of WW-II with greater productive capacity than at the start of the warconsumer demand grew vigorously in the immediate years after the war (partly a result of “4 years of going without,” due to wartime rationing)technical change (invention and innovation) => automated production process for many different goods, driving down costs for: passenger air tourism, television, dishwashers, laundry machines, and other goodsGood outcomes for several decades post WW-IILow Inflation Rates from 1949 through 1967Low Unemployment Rates from 1948 through 1974Keynesianism and a greater role for government seemed to deliver the promise of “growth and full employment”Lyndon Johnson’s “Great Society”:Role of the federal government in the economy was further expanded under President Lyndon Johnson (1963-1969)“Great Society” – series of domestic programs proposed by and initially enacted under the leadership of President Johnson, with the two main goals of eliminating poverty and racial injustice.Larger role of government under “Great Society” included:Elementary and Secondary Education Act of 1965 – significant federal aid to public schools for first timeHigher Education Act of 1965 – substantially increased federal funds to universities; created scholarships and low-interest loans for studentsSocial Security Act of 1965 – created Medicare, under which the federal government would provide medical care for the elderly (and others, such as the disabled)Medicaid – federal program to provide funding for medical services for low income individuals in the U.S.National Foundation for the Arts and Humanities Act of 1965 – created the “National Endowment for the Arts” and “National Endowment for the Humanities,” to provide targeted federal funding for Arts and HumanitiesEnvironmental Legislation – first time that federal government enacted environmental policies with aim of more than just protecting or conserving untouched resources (e.g., Endangered Species Preservation Act of 1966; Land and Water Conservation Act of 1965; Solid Waste Disposal Act of 1965; Motor Vehicle Air Pollution Control Act of 1965; National Environmental Policy Act of 1969)Economic Policies of Nixon Administration:Stagflation – simultaneous realization of higher inflation along with increased unemployment and decreased growthPoor economic performance during Nixon’s first term:Annual Inflation Rate up to 5.84% in 1970 (had been below 2% from 1959-1965)Unemployment Rate up to 5.95% in 1971 (had been below 4% from 1966-1969)“breakdown of the Phillips Curve” => Misery Index of 10.82 in 1970 (over 10 for first time since June 1958)GDP Growth Rate of only 0.2% in 1970Before the middle of his first term, Nixon appeared to be a strong critic of government intervention in the economy (particularly had a strong opposition to the “price controls” instituted in U.S. during WW-II).“Philosophy” took a back seat to “politics” during Nixon’s first administrationNixon unsuccessfully ran for president in 1960, when he was the Vice President under President Eisenhowerrecession in 1960 => Nixon narrowly lost to JFK:popular vote was 49.7% to 49.6% in favor of JFK;Electoral College was 303 to 219 in favor of JFKallegations of voter fraud in IL and TX (some precincts in which more votes were cast than the number of total registered voters) => if both had gone to Nixon, he would have wonlooking forward to the 1972 election, Nixon wanted a “strong economy”“Big Question” was: “How to bring down inflation without further slowing the economy and raising unemployment?”January 1971: Nixon declared, “Now I am a Keynesian,” and he subsequently introduced a “Keynesian ‘full-employment’ budget” providing for deficit spending to reduce unemploymentIn an attempt to combat inflation, he imposed “price controls”Price Control – a legal restriction on the price at which trade can take place (i.e., “price ceiling” or “price floor”).Price Ceiling – a maximum legal price at which trade can take place.Price Floor – a minimum legal price at which trade can take place.Analysis of price controls: “Economics” – Chapter 7, pages 117–122In general, both “price ceilings” and “price floors” will lead to “less than the efficient level of trade” taking place in a market, and therefore will create a positive Deadweight-Loss.Outcome in the presence of a “Price Ceiling”:ecdDemand4,8009,700b2.35quantity6,750a5.053.70f00“Excess Demand” at level of “price ceiling”Supplyprice“free market outcome”: 6,750 units traded, each at a price of $3.70; CS=(a+b+e); PS=(c+d+f); DWL=(0).Suppose society decides this price is “too high” and imposes a “price ceiling” of .Consumers want to buy 9,700 units, but firms only wish to sell 4,800.4,800 units will be traded (less trade)Trade takes place at $2.35 (lower price, for those who do get to purchase the item)PS=(d): decrease in PS of (c+f)CS=(a+b+c): change of (c-e) (total change in CS may be either positive or negative)DWL=(e+f): positive DWL, implying an inefficiencyResult: lower social welfare; all sellers clearly worse off; some buyers better off, but some buyers worse off (those who no longer get the item); total Consumers’ Surplus may be either smaller or larger than beforeNixon’s Price Controls:Implemented in the early 1970’sAdministered by the “Cost of Living Council” (led by Director Donald Rumsfeld and Assistant Director Richard Cheney)Initially did keep inflation in check => Nixon reelected in 1972 in a landslide over George McGovernpopular vote was 60.7% to 37.5% in favor of NixonElectoral College was 520 to 17 in favor of Nixon (the only larger margin was Reagan’s defeat of Mondale in 1984 by a difference of 525 to 13) => see “county-by-county maps” for illustration of magnitude of landslidePrice controls had negative consequences over timeBy 1973 “shortages” were artificially created in many markets: ranchers stopped shipping cattle to markets; farmers drowned chickens; supermarket shelves were emptiedSystem finally abolished in 1974 => double digit inflation for 15 straight months from February 1974 through April 1975George Shultz (head of the “Office of Management and Budget”) commented to Nixon that, “At least we have now convinced everyone else of the rightness of our original position that wage-price controls are not the answer.”73.0% of economists agree that: “Wage-Price Controls are NOT a useful policy option in the control of inflation.”2008: Obama (blue) v. McCain (red)Popular: 52.9% to 45.7%Electoral College: 365 to 173 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET 2000: George W. Bush (red) v. Gore (blue)Popular: 47.9% to 48.4%Electoral College: 271 to 266 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET 1988: George H.W. Bush (red) v. Dukakis (blue)Popular: 53.4% to 45.7%Electoral College: 426 to 111 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET 1980: Reagan (red) v. Carter (blue)Popular: 50.7% to 41.0%Electoral College: 489 to 49 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET 1976: Carter (blue) v. Ford (red)Popular: 50.1% to 48.0%Electoral College: 297 to 240 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET 1972: Nixon (red) v. McGovern (blue)Popular: 60.7% to 37.5%Electoral College: 520 to 17 INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET INCLUDEPICTURE "" \* MERGEFORMATINET Poor Economic Performance of 1970s and early 1980s:1970s & early 1980s: very poor economic performance.Annual Inflation Rate: would reach 12.34% in December 1974 (highest level since WW-I); would peak at 14.76% in March 1980; “double digit inflation” as late as October 1981 (10.14%)Unemployment Rate: 9.00% by May 1975; would peak at 10.8% in November 1982Another apparent “breakdown of the Phillips Curve”Negative growth rate for Real GDP in: 1974 (–.6%), 1975 (–.2%), 1980 (–.3%), and 1982 (–1.9%)These experiences led to a change in thought regarding the “optimal role of government”Confidence in government knowledge was now turning to cynicismKeynesian paradigm not what it seemed to be – not all that easy to “manage the economy” by “wielding the levers of fiscal policy”Herbert Stein (Chairman of “Council of Economic Advisors” under Nixon; father of Ben Stein):“…inflation rate was high, real economic growth was slow, and our ‘normal’ unemployment rate…was higher than ever. Nothing was more natural than the conclusion that the problems were caused by all these government increases (in spending, taxes, regulation) and would be cured by reversing, or at least stopping, them.”Message of 1970’s was: “…government could fail, too. Perhaps markets were not so dumb after all.” ................
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