short-term economic fluctuations: an introduction
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Short-Term Economic Fluctuations: An Introduction. Long Run vs. Short Run. The economic “climate” Long-run economic conditions are the ultimate determinant of living standards Changes in the economic “weather” Short-run fluctuations are important to our day-to-day existence. Recessions. - PowerPoint PPT PresentationTRANSCRIPT
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Short-Term Economic Fluctuations: An
Introduction
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Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Long Run vs. Short Run
The economic “climate” Long-run economic conditions are the
ultimate determinant of living standards
Changes in the economic “weather”Short-run fluctuations are important to
our day-to-day existence
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RecessionsRecession [or Contraction]
A period in which the economy is growing at a rate significantly below normal
A period during which real GDP falls for at least 6 consecutive months
Recent recessions have lasted between 6 and 16 months
DepressionA particularly severe or protracted recession
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RecessionsDuration
Length of recessionsPeak
The beginning of a recessionThe high point of economic activity prior to a
downturnTrough
The end of a recessionThe low point of economic activity prior to a
recovery
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Fig. 12.1Fluctuations in U.S. Real GDP,
1920-1999
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Expansions
ExpansionA period in which the economy is growing
at a rate significantly above normalNormally lasts longer than recessions
BoomA particularly strong and protracted
expansion
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Cyclical?
Cyclical fluctuationsBusiness cycles
Might imply that economic fluctuations are regular
However, economic fluctuations are quite irregular in their length and severity
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Fig. 12.2U.S. Inflation, 1960-1999
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Characteristics of SR Fluctuations
Expansions and recessions areFelt throughout the economy and often
globallyFelt not just in a few industries
The unemployment rate Typically rises sharply during recessionsRises because of cyclical unemployment
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Characteristics of SR Fluctuations
RecessionsTend to be preceded by inflationTend to bring lower inflation rates
Durable goodsCars, houses, capital equipmentSensitive to fluctuations
Services and nondurablesFoodMuch less sensitive to fluctuations
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Potential Output
Potential output or Potential real GDPFull 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
Grows over timeY*
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Causes of RecessionA recession occurs when the economy is
growing significantly below its normal rateTwo possibilities
Actual output equals potential output, but potential output is growing slowlyAppropriate policy responses include long-run solutions
(Part VI)Promote saving, investment, technological innovation,
human capital formationActual output does not always equal
potential output (i.e., a recessionary gap)
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Output Gaps
Output gap (Y* - Y)The difference between the economy’s
potential output and its actual output at a given point in time
Y is actual real GDPY* is potential real GDP
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GapsRecessionary gap (Y* > Y)
A positive output gap, which occurs when potential output exceeds actual output
A condition when an economy’s capital and labor resources may not be fully utilized
Expansionary gap (Y* < Y)A negative output gap, which occurs when actual
output is higher than potential outputA condition when an economy’s resources are
being over-utilized
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Fig. 12.3Actual and Potential Output
in Japan, 1980-2000
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Unemployment and Gaps
During a recessionary gapLow utilization of resources occurs
A high unemployment rate causes output to fall below potential
During an expansionary gapOver utilization of resources occurs
Low unemployment rate
Hence, output is higher than potential
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Types of UnemploymentFrictional
Short-term matching of workers and jobsAlways present
StructuralLong-term chronic—mismatch of skills of
workers and skills required for jobsAlways present
CyclicalExtra unemployment during periods of recessionOnly present during recessions
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Natural Rate of Unemployment
Natural rate of unemployment [u*]The part of the total unemployment rate
that is attributable to frictional and structural unemployment
The unemployment rate that prevails when cyclical unemployment equals zero
The unemployment rate that exists when an economy has neither an expansionary gap nor a recessionary gap
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Cyclical UnemploymentCyclical unemployment: u - u*
Actual unemployment rate: uNatural rate of unemployment: u*
Recessionu – u* is positive (u > u*)Positive cyclical unemployment
Expansionu – u* is negative (u < u*)Negative cyclical unemployment: Labor is being
used more intensively than normal
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Okun’s Law
Okun’s LawEach extra percentage point of cyclical
unemployment is associated with about a 2 percentage point increase in the output gap
Measured in relation to potential output
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Significant Costs
Output gaps and cyclical unemployment have significant costs1982 recessionary gap = $357 billion, in
1992 dollars1982 U.S. population = 230 millionHence, the output loss was around $1,550
per person or about $6,000 per family
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Reasons for Output Gaps1. Some prices adjust slowly
Firms “meet the demand” at a preset price in the short run
2. Economy-wide spending changesMajor cause of output gaps
3. Firms change pricesRaise prices in response to expansionary gaps Lower prices in response to recessionary gaps
4. Economy self-corrects Tends to eliminate output gaps in the long run