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How Does the U.S. Economy Work

By , About.com Guide

Have you ever said to yourself - "Exactly how does the U.S. economy work?" During a recession, you might think "Not too well!" Learn the causes of recession by understanding Gross Domestic Product (GDP) and the laws of supply and demand. Know how the Federal Government uses fiscal and trade policy. Realize how the Federal Reserve fights inflation while spurring growth with monetary policy. See how financial markets on Wall Street influence Main Street and your neighborhood.
  1. GDP
  2. Supply and Demand
  3. Inflation and Deflation
  4. Fiscal Policy
  1. Monetary Policy
  2. Trade Policy
  3. Financial Markets
  4. Glossary

GDP

Everything the U.S. economy produces is measured by GDP, or Gross Domestic Product. When GDP turns negative, the economy enters a recession. When this goes on for years, its called a depression. Find out the components of GDP, what is health growth, and what causes a recession. Learn the difference between recession and depression.

Supply and Demand

How supply and demand are the forces that drive the U.S. economy. Supply includes employment and natural resources such as oil. Demand, or personal consumption, drives 70% of the economy. A lot of this occurs during the holiday shopping season, which starts on Black Friday.

Inflation and Deflation

Inflation is what happens when demand is greater than supply, and prices go up. It is very difficult to stamp out, once people begin to expect ever higher prices. That's because they will buy now before prices go up, increasing demand even more. Deflation is the opposite, and occurs when prices fall. This also happens to assets, such as housing prices and stock portfolios.

Fiscal Policy

Fiscal policy is the controversial $3.5 trillion Federal budget. All the revenue ultimately comes from taxes on your income, so it is important for you to know how it is spent. Fiscal policy can stimulate, guide or depress the economy, but only business can create economic growth. Learn about the budgeting process, including the role of the President, Congress, and the Budget Office (OMB). Find out about Federal tax policy. Understand the budget deficit, and how ongoing deficits led to the $13 trillion national debt.

Monetary Policy

Monetary policy is controlled by the Federal Reserve, which is guided by the Fed Chairman, Ben Bernanke. The Fed's three key economic controls are the Fed funds rate, the money supply and the use of credit. The primary objective of monetary policy is to control inflation. It's secondary objective is to stimulate the economy. It is also charged with the smooth functioning of the banking system. For this reason, the Federal Reserve Chairman is often called the most powerful man on the planet.

Trade Policy

Trade policy affects the cost of imports and exports by regulating trade agreements with other countries. Learn how exchange rates affect trade, the value of the dollar and why the dollar is losing value. Understand trade regulation, including farm subsidies and tariffs, affect inflation. Find out the facts about NAFTA and other trade agreements. Learn about the importance of the World Trade Organization, the Doha round of agreements, and trade disputes.

Financial Markets

An implosion in the financial markets has thrown the economy into the worst recession since the Great Depression. How did this happen? It began with derivatives that were supposed to insure against defaults on sub-prime mortgages. When insurers like AIG defaulted themselves, panic gripped Wall Street, spreading throughout the world. To understand the global financial meltdown, you must learn the basics of the stock market: stocks, bonds, and mutual funds. Then you can comprehend the more exotic hedge funds, commodity trading and credit default swaps.

Glossary

Here are some easy-to-understand definitions of terms most commonly used in discussing the U.S. economy.

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