Ch 24

Question 1

Business Cycles

Answer 1

short-term fluctuations in GDP and other variables

Question 2

A recession (or contraction)

Answer 2

is a period in which the economy is growing at a rate significantly below normal
A period during which real GDP falls for two or more consecutive quarters
A period during which real GDP growth is well below normal, even if not negative
A variety of economic data are examined

Question 3

A depression

Answer 3

particularly severe recession

Question 4

A peak

Answer 4

is the beginning of a recession

High point of the business cycle prior to a downturn

Question 5

A trough

Answer 5

is the end of a recession

Low point of the business cycle prior to a recovery

Question 6

An expansion

Answer 6

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

Question 7

A boom

Answer 7

strong and long lasting expansion

Question 8

Potential output Y*

Answer 8

is the maximum sustainable amount of output that an economy can produce
Also called full-employment output
Use capital and labor at greater than normal rates and exceed Y* – for a period of time

Question 9

Actual output grows at a variable rate

Answer 9

Reflects growth rate of Y*
Variable rates of technical innovation, capital formation, weather conditions, etc.
Actual output does not always equal potential output

Question 10

The output gap

Answer 10

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

Output gap (in percent) = y - y/ y x 100

Recessionary gap is a negative output gap; Y* > Y
Expansionary gap is a positive output gap; Y* < Y

Question 11

Policy makers consider stabilization policies when there are output gaps

Answer 11

Recessionary gaps mean output and employment are less than their sustainable level
Expansionary gaps lead to inflation: firms are faced with a demand that exceeds their normal capacity, so they raise prices

Question 12

Frictional unemployment

Answer 12

Short-term unemployment related to matching of workers and jobs

Question 13

Structural unemployment

Answer 13

Long-term chronic unemployment in normal conditions – perhaps skills are outdated

Question 14

The natural rate of unemployment u*

Answer 14

is the sum of frictional and structural unemployment
Unemployment rate when cyclical unemployment is 0
Occurs when Y is at Y*

Question 15

Cyclical unemployment is the difference between total unemployment, u, and u*

Answer 15

Recessionary gaps have u > u*

Expansionary gaps have u < u*

Question 16

Age structure of the population has changed

Answer 16

Share of working age population ages 16 – 24 has declined from 25% to 14%
This group has higher unemployment than older workers
Short-term jobs
Career shopping
Interrupt work for school or military service
Frequent job changes increases frictional unemployment
Lower skills among the young means less structural unemployment

Question 17

Labor markets may be more efficient at matching job openings and workers

Answer 17

Reduces frictional and structural unemployment
Temporary agencies 
Temp work can lead to permanent position
Online job boards
Less time between jobs

Question 18

Okun’s law

Answer 18

relates cyclic unemployment changes to changes in the output gap
One percentage point increase in cyclical unemployment means a 2 percent widening of a negative output gap, measured in relation to potential output

Question 19

Suppose the economy begins with 1% cyclical unemployment and an recessionary gap of -2% of potential GDP

Answer 19

If cyclical unemployment increases to 2%, the recessionary gap increases to -4% of potential GDP

Question 20

Output gaps arise for two main reasons

Answer 20

Markets require time to reach equilibrium price and quantity
Firms change prices infrequently
Quantity produced is not at equilibrium during the adjustment period
Firms produce to meet the demand at preset prices

Question 21

Changes in total spending at preset prices affects output levels

Answer 21

When spending is low, demand is low and output will be below potential output
Changes in economy-wide spending are the primary causes of output gaps
Policy: adjust government spending to close the output gap

Question 22

The economy has self-correcting mechanisms

Answer 22

Firms eventually adjust to output gaps
If spending is less than potential output, firms will slow the increase of their prices, or even cut prices, reducing inflation
If spending is more than potential output, firms increase prices
Potential inflationary pressure
Eventually, prices reach equilibrium and eliminate output gaps
Production is at potential output levels
Output is determined by productive capacity
Spending influences only price levels and inflation