Chapter 21 - Short-term economic fluctuations

Recessions and expansions

• Business cycles: short-term fluctuations in GDP and other variables.

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• Recession = contraction: period in which the economy is growing at a rate significantly below normal.

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• Depression: particularly severe or protracted recession.

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• Peak: beginning of a recession; the high point of economic activity prior to a downturn.

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• Trough: end of a recession; the low point of economic activity prior to a recovery.

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• Expansion: period in which the economy is growing at a rate significantly above normal.

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• Boom: particularly strong and protracted expansion.

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Output gaps and cyclical unemployment

• Potential output, Y* (or potential GDP or full employment output): maximum sustainable amount of output (real GDP) that an economy can produce.

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• Output gap: difference between the economy's actual output and its potential output, relative to potential output, at a point in time.

• Recessionary gap: negative output gap, which occurs when potential output exceeds actual output (Y < Y*).

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• Expansionary gap: positive output gap, which occurs when actual output is higher than potential output (Y > Y*).

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• Natural rate of unemployment, u*: part of the total 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.

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• Okun's law: each extra percentage point of cyclical unemployment is associated with about a 2 percent widening of a negative output gap, measured in relation to potential output.

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