Week 6

We call this sacrifice of output a GDP gap. The GDP gap is the difference between ____ and ____ GDP

GDP Gap= actual GDP - potential GDP

______________ and ___________ are somewhat insulated (or protected) from severe effects of recessions. This is because it is difficult to cut back on doctor visits and food

Service industries and non-durable consumer goods

In the United States, the Bureau of Labor Statistics (BLS) divides the population into 3 groups:

Under 16 years old and/or the institutionalized Labor force: people able and willing to work Not in labor force: people who are of age, but not employed and not seeking work (for example, full-time students, stay-at-home parents).

Recession

an economic downturn marked by a decrease in GDP for two consecutive quarters (the downturn must last 6 months or more to be labeled a recession).

Okun's Law

for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP gap of about 2 percent occurs. -for example, if our current natural rate of unemployment is 6%, but we are experiencing 7% unemployment, that would mean that we have an excess of 1% unemployment occurring. According to Okun, this would mean that we would see a GDP gap of 2%, meaning we would have a loss of production output in our economy of about 2%.

Three types of unemployment

frictional (temp between jobs) , structural (demand for certain skills may disappear), cyclical (Results from insufficient demand for goods and services. Very serious problem when it occurs)

The unemployment rate that is consistent with full employment is called the _________. The full-employment rate of unemployment is also known as the ___________

full-employment rate of unemployment -natural rate of unemployment (NRU).

Financial instability Unexpected financial____________ or __________can spill over to the general economy by expanding or contracting lending Booms and busts in the rest of the economy may follow

- bubbles (rapid asset price increase) -busts (abrupt asset price decrease)

Productivity changes Unexpected increase → Unexpected decrease → Can result from unexpected changes in _______ or ________

- economy booms -economy recedes -resource ability or general rate of technological advance

Spending rises → [prices sticky] → consumers buy____ → firms increase_______ → GDP______ → employment _______ → economy booms; ______

- more -output -rises -rises -expansion

So in the short-run, the economy is forced to deal with shocks by changes in___ and ______ rather than by changes in prices (because those prices are sticky and not moveable immediately)

- output and employment

negative GDP gap________ positive GDP gap_______

-(actual GDP < potential GDP) -(actual GDP > potential GDP)

_______ all pass through the same phases, but they vary greatly in duration and intensity. The start and end of recessions are declared by The Business Cycle Dating Committee of the _________________(NBER). Recessions are not just a U.S. thing; all countries experience them

-Business cycles -National Bureau of Economic Research (NBER)

The Labor Force is the only one of the three categories which has sub-categories. These sub-categories are: _______- and _________

-Employed (meaning you are working; doesn't have to be full-time) and -unemployed (people who are willing and able to work and actively seeking work within the last 4 weeks)

When the economy fails to create enough jobs for all who are willing and able to work, potential production of goods and services is irretrievably lost (another way to think of it is that we are operating inside the __________

-Production Possibilities Frontier, or PPF).

Expansion:

-Real GDP, income and employment rise Economy approaches full employment If spending expands more rapidly than production capacity, prices of nearly all goods and services rise (inflation)

Irregular innovation

-Some inventions rapidly spread through economy. Once everyone uses new technology, economy may slow after

Trough:

-The "bottom" of the downturn Output and employment "bottom out" at their lowest levels May be short-lived or very long phase

Depression:

-an especially deep and long-lasting recession.

Firms and industries producing __________ and _________ are affected the most by the business cycle. This is because firms and households can often _______ these purchases and therefore will not purchase them during economic downturns.

-capital goods (heavy equipment, housing, etc) and consumer durables (cars, computers, etc) -postpone

Structural: This kind of unemployment is when demand for ____________ or the __________________ (the entire industry may relocate to another geographical location). This type of unemployment makes it difficult for people to find new jobs without re-training. This is slightly more concerning, especially for older workers.

-certain skills either disappears altogether, -demand for labor changes geographically

Contraction: A period of ______ in total output, income, and employment Widespread contraction of business activity in many sectors of the economy Significant ________ in unemployment occurs Recession: Depression:

-decline -increases

Cyclical: This is unemployment which is caused by a ____________ It results from insufficient demand for goods and services. Cyclical unemployment is a very serious problem when it occurs, and requires policy interventions.

-decline in total spending.

Economists believe most short-run fluctuations in GDP (Percentage change of deviations from potential GDP) and the business cycle are the result of ______

-demand shocks

Business cycles are alternating rises and declines in the level of ________, sometimes over several years. Individual cycles (one "up" followed by one "down") vary substantially in _____ and ______

-economic activity -duration and intensity

As we saw in the previous module, the long-run trend has been one of economic growth in the United States. However, this growth has not been constant - it has been interrupted by periods of ________, usually associated with ________

-economic instability -business cycles.

The economy is said to be "fully employed" when it is only experiencing ______ and _____unemployment. This is because we expect to see these types of unemployment in any healthy and functioning economy.

-frictional and structural

Macroeconomics has to take into account expectations about the ______ Expectations are what we believe _________

-future. -will happen

The areas where our actual GDP were ____________are shaded in blue. How could we actually achieve more than our potential? Recall how we defined our full-employment level of output: we accepted that we would always have some frictional and structural unemployment occurring

-greater than our potential GDP -produce more than our potential, what is happening is that we managed to have even smaller frictional and structural unemployment than we figured would always occur in our economy.

Why are demand shocks such a big deal? Prices of many goods and services are _________ (another way we describe this inflexibility is to call these prices_______. Because of this, price changes do not quickly equalize the ________________

-inflexible - sticky -equalize the quantities demanded of the goods and services with their respective quantities supplied

Sticky prices (also known as ________ help to explain how unexpected changes in demand lead to the_________ and ________ that occurs over the course of the business cycle.

-inflexible prices) - fluctuations in GDP and employment

Peak: Business activity hits temporary _______ Economy at or near ______ employment Level of real output at or very close to economy's ________ Price levels likely to_____during this phase

-maximum -full -capacity - rise

Monetary factors Nation's central bank shocks economy by creating more ___ than people expected → __________________ If print less money than expected → _____________________

-money -inflationary boom in output occurs. -decline in output and price level falls.

The areas where the actual GDP were lower than the potential GDP resulted in a _____

-negative gap (shown in yellow shading)

Spending shrinks → [prices sticky, so not lowered] → firms sell fewer _______ → firms cut ______ → GDP ______ → employment falls → economy contracts; enter ______

-output -production -falls -recession

Political events Unexpected ______ or _________ can create economic opportunities or strains Economy may face upswings or downswings in adjusting

-peace treaties or terrorist attacks

The main idea is that fluctuations are driven by ____ - unexpected events that firms and individuals have trouble adjusting to. -________ is thought to be why the economy does not quickly adjust to shocks

-shocks -Price stickiness

Situations in which something unexpected occurs are known as _______ Economies have both _______ and ________

-shocks. -demand shocks and supply shocks.

Supply shocks: unexpected changes in the ____ of goods and services

-supply

Not all prices are sticky. Certain products have flexible prices. Flexible prices react within seconds to changes in ____________

-supply and demand -(some examples include: corn, oil, natural gas).

Frictional: These are people who are ______________-. These individuals have ________________ or ______________This is the least-concerning type of unemployment which exists.

-temporarily between jobs. -marketable skills and live where jobs exist, or can move to where jobs exist.

To calculate the unemployment rate, we want to find the number of unemployed people out of the total number of people who could be working. This is why we divide the number of _______ by ________

-unemployed by the labor force in our ratio below.

Demand shocks: _____________________________________________ ____________: situations in which demand turns out to be higher than expected ____________: situations in which demand turns out to be lower than expected

-unexpected changes in the demand for goods and services -"positive demand shock" -"negative demand shocks"

Criticisms of BLS Survey

1. Part-time employment (technically has job but not survivable wage) 2. Underemployed (skill does not match job professor working as dishwasher) 3. Discouraged workers: people who have been looking for work so long unsuccessfully, that they just give up ("Not in the Labor Force,")

Economists cite several possible general sources of shocks that can cause business cycles: 1, 2, 3, 4, 5,

1. irregular innovation, 2.productivity changes, 3.monetary factors, 4. political events, 5. financial instability.