ECO 103 Chp. 12

Recession

Recession

a period in which the economy is growing at a rate significantly below normal

• Informally, a period during which real GDP falls for at least two consecutive quarters

Depression

an extremely severe or protracted recession

Peak

the beginning of a recession; the high point of economic activity prior to a downturn

Trough

the end of a recession, the low point of economic activity prior to a recovery

Expansion

a period in which the economy is growing at a rate significantly above normal

Boom

a particularly strong and protracted expansion

Business cycles (or cyclical fluctuations)

short-term fluctuations in GDP and other indicators of economic activity

Durable goods

goods that yield utility over time and are made to last for three + years

• Ex. cars, houses, capital equipment

• Are more affected than others by recessions and booms

Nondurable goods

goods that can be quickly consumed or immediately used, having a life span of less than three years

• Ex. food

• Are less sensitive by short-term fluctuations in the economy

Potential output (or potential GDP or full-employment output)

the amount of output (real GDP) that an economy can produce when using its resources such as capital and labor, at normal rates

• Potential output is not the same as maximum output

• Is not a fixed number but grow over time

  • Reflects increases in both the amounts of available capital and labor nd their productivity

• The growth in potential output is much smoother than actual output

Determinants of output growth speed

1. Changes in the rate at which the country’s potential output is increasing

   1. Ex. unfavorable weather conditions like a severe drought would reduce the rate of potential output growth in an agricultural economy

2. Actual output does not always equal potential output

   1. Potential output may be growing normally but for some reason, the economy’s capital and labor resources may bot be fully utilized so actual output is significantly below potential output

Output gap

the difference between the economy’s actual output and its potential output at a point in time

• Output gap in percent= ((actual output - potential output) / (potential output)) x 100

Recessionary gap

the difference between the economy’s actual output and its potential output at a point in time

• Output gap in percent= ((actual output - potential output) / (potential output)) x 100

Frictional unemployment

short-term unemployment that is associated with the matching of workers and jobs

Structural unemployment

long-term and chronic unemployment that occurs even when the economy is producing at its normal rate

Cyclical unemployment

the extra unemployment that occurs during periods of recession

• The difference between the total unemployment rate and the natural rate

• Is positive when the economy has a recessionary gap

• Is negative when there is an expansionary gap

• Is zero when there is no output gap

Natural rate of unemployment

the part of the unemployment rate that is attributable to frictional and structural unemployment; equivalently, the unemployment rate that prevails when cyclical unemployment is zero so that the economy has neither a recessionary nor an expansionary output gap

= frictional + structural unemployment rates

Okun’s law

each extra percentage point of cyclical unemployment is associated with about a 2% point increase in the output gap, measured in relation to potential output

• Ex. cyclical unemployment increases from 1% to 2% of the labor force

  • Then, the recessionary gap will increase from -2% to -4% of potential GDP

Recession

a period of falling incomes and rising unemployment

Depression

a severe recession

Output gap

measures how far output is from its normal level at a particular time

Potential output

the maximum sustainable amount of output that an economy can produce

• Is not the same as maximum output

  • Higher utilization of capital and labor, can lead to actual output exceeding potential output

• Is not a fixed number but grows over time

  • Reflects increases in the amounts of available capital and labor and their productivity

• Is predicted to grow smoothly

Short-run fluctuations in an economy causes

• Changes in the rate at which the economy’s potential output grows

• Actual output does not always equal potential output

Output gap

the difference between the economy’s actual output and its potential output, relative to potential output, at a point in time

Two forms of output gaps:

1. Recessionary gap- negative output gap; actual output < potential output

   1. Mean that output and employment are less than their sustainable level

2. Expansionary gap- positive output gap; actual output > potential output

   1. Leads to inflation

Natural rate of unemployment

the sum of frictional and structural unemployment

• Cyclical unemployment (extra unemployment that occurs during recessions) is the natural unemployment rate when it is 0

Okun’s law

relates cyclical unemployment changes to changes in the output gap

• One percentage point increase in cyclical unemployment means a 2% widening of a negative output gap, measured in relation to potential output

Output gap causes

1. Markets require time to reach equilibrium price and quantity

   1. Firms change prices infrequiently

   2. Quantity produced is not at equilibrium during the adjustment period

   3. Firms produce to meet the demand at current prices

2. Changes in the total spending at present prices affects output levels

   1. When spending is low, output will be below potential output

   2. Changes in economy-wide spending are the primary causes of output gaps

• In response, the government can adjust spending to close the output gap