Economic Theories to Control Business
Cycle

Option 1: No government
interference- Adam Smith
 Supply
and demand
will eventually find
equilibrium price and
the cycle will even out

Option 2: Government
helps even out the business
cycle- John Maynard
Keynes
Laissez faire economics: No
interference by government




Adam Smith writes Wealth
of Nations
Written in 1776
Criticizes mercantilism
Criticizes protective tariffs



Charge on importing a
good
Believes that supply and
demand are the “invisible
hand” of economics
Customers will always look
for the highest quality and
the cheapest price
Keynesian Theory: Government should
set in


Idea of John Maynard
Keynes
Government can control
business cycle by how
much it spends
Government can raise
and lower taxes
 Government can control
how much it spends


Government can create
demand
Fiscal Policy

Government can raise or
lower taxes
Raise taxes- Less
demand
 Lower taxes- Higher
demand


Government can raise or
lower government
spending
Raise spending- Higher
demand
 Less spending- Lower
demand

Government can raise personal income
taxes
1. Government raises taxes in
expansion
2. People have less money to spend
3. Less demand
4. Less demand means lower prices
5. Controls inflation or the rise in prices
Government can lower personal income
taxes
1. Government would lower taxes in a
recession
2. People have more money to spend
3. Demand is created
4. More demand means that businesses
will increase supply because they are
selling more
5. Production goes up
6. More workers are needed to keep up
with production
7. Unemployment is reduced. Country
gets out of recession
Government can spend more money
1. Government spends money in a
recession.
2. Government is increasing demand
3. Businesses will want to increase supply
4. More workers are needed to keep up
with production.
5. Unemployment goes down due to
increased production.
6. More people have money to spend
7. Demand continues to go up.
8. Businesses can continue to hire.
9. Country gets out of recession
Government can decrease spending
1. Government decreases spending in
an expansion.
2. Government buys less stuff.
3. Lowers demand.
4. Prices go down. Businesses reduce
supply because not making any money.
5. Lay off workers or downsize
6. People have less money to spend.
7. Demand continues to decrease.
8. Prices continue to fall. Leads to
deflation.
Lower corporate taxes: Supply side
economics


Idea of Ronald
Reagan in the 1980’s
Also known as trickle
down economics
1. Lower corporate income taxes in a recession
2. This lowers the cost of running a business
3. Lower costs leads to increased supply.
4. Increase in supply leads to decreased prices.
5. Lower prices create demand.
6. Demand leads to increased production.
7. Businesses can hire more employees.
8. Unemployment rate decreases.
9. Joe the Plumber has more money.
10. Joe can buy more.
11. Demand continues to increase. GDP goes up. Get
out of recession