Chapter 10: Short Term

Economics FluctuationsMacroeconomics

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Short Term Fluctuation

• Four Phases Business cycle

• Recession and Expansions Characteristic

• Unemployment

• The differences between short run and long run

Four Phases Business Cycle

• Juglar Cycle:

– 1. Expansion (increase in production and prices, low interest rate)

– 2. Crisis (Stock exchange crisis, bankruptcies)

– 3. recession (drops in prices and in output, high interest rates)

– 4. recovery (stocks recover, productivity increases, consumer confidence increases, aggregate demand increases)

The Periodic of Business Cycle

• Juglar Cycle: 8-11 years

• Kitchin Inventory cycle: 3-5 Years

• Kuznet infrastructural investment cycle: 15-25 years

• Kondratiev Wave: 40-60 Years

Definition

• Recession/ Contraction: a period in which the economy is growing at a rate significantly belownormal

• Depression: A particularly severe or protractedrecession

• Peak: The Beginning of a recession, the high point of economic activity prior to a downturn

• Through: the end of recession.

• Expansion: a period in which the economy is growingat a rate significantly above normal

• Boom: a particularly strong and protracted expansion

Recession Shape

• Recession shapes are used to portray the type of recession.

• Generally, there are 4 type of recession shape:

– V Shape recession

– U Shape recession

– W Shape recession

– L Shape recession

V Shape Recession

• For example is: US Recession in 1953

U Shape Recession

• For example US crisis during 1973-1975

W Shape Recession

• A W-shaped recession or "double dip" recession, occurs when the economy has a recession, emerges from the recession with a short period of growth, but quickly falls back into recession.

L Shape Recession

• For Example Japanese Asset Pricing Bubble in 1990.

4 Important Indicators of Recession

• Industrial Production, which measures the output of factories and mines

• Total sales in manufacturing, wholesale trade, and retail trade

• Nonfarm employment

• Real after-tax income received by household, excluding the transfer payment

Additional Information

• Unemployment is a key indicator of short term economic fluctuation. It rises sharply during a recession and falls during expansion

• Inflation will increased before recession and then after recession the inflation will be declined

• Unemployment because of the recession called as cyclical recession

Output Gap

• Output Gap occurs during recession. It measures how far output is form its normal level at a particular time

• To examine this output gap, we revisit its relationship to cyclical unemployment and the Potential output.

• Potential output is the maximum sustainable amount of output (real GDP) than an economy can produce

Short Run Fluctuation

• WHY?

– Changes in the rate of output growth may reflect changes in the rate at which the country’s potential output is increasing.

– Actual output does not always equal potential output

• The difference between actual output and its potential output at a point is called as output gap

• If the Potential Output > Actual Output -> Recessionary Gap

• If the Potential Output < Actual Output -> Expansionary Gap

Problem 3

Year Real GDP Potential GDP Output gap Type of gap

Growth rate of real

GDP

1999 $9,470 $9,248 2.4% expansionary

2000 $9,817 $9,590 2.4% expansionary 3.7%

2001 $9,891 $9,927 -0.4% recessionary 0.8%

2002 $10,049 $10,227 -1.7% recessionary 1.6%

2003 $10,301 $10,501 -1.9% recessionary 2.5%

2004 $10,676 $10,777 -0.9% recessionary 3.6%

2005 $11,003 $11,068 -0.6% recessionary 3.1%

2006 $11,319 $11,372 -0.5% recessionary 2.9%

2007 $11,567 $11,687 -1.0% recessionary 2.2%

• The growth rate of GDP slowed to 0.8% in 2001; growth accelerated from 2002 to

2004, corresponding to the official dating of the recession. Note, however, that a

recessionary gap continued throughout the 2001-2007 period, meaning that despite

the resumption of normal growth rates the economy never caught up with potential

after the 2001 recession.

Which one is better? Recessionary or Expansionary?

• None of them!

• Recessionary Gap indicates capital and labor resources are not being fully utilized

• Expansionary Gap will increase inflation and cause inefficiency in long run

• An important indicator of the law utilization of resources during recession is unemployment

• Natural Rate of unemployment is the part of the total unemployment rate that is attributable to frictional and structural unemployment

• Therefore, we can surmise Cyclical Unemployment is equal to the difference between total unemployment and natural rate

OKUN LAW

• It links the output gap and the amount of cyclical unemployment.

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

- If cyclical unemployment increases from 1 percent to 2 percent of the labor force, the recessionary gap will increase from 2% to 4% of GDP

a. In 2010, real GDP is 2% below potential GDP, so cyclical unemployment is 1%. Since the actual unemployment rate is 6%, the natural rate must be 5%.

b. In 2011, the natural rate equals the actual rate, so cyclical unemployment equals zero. Okun’s law implies that the output gap is therefore zero, and potential output equals the actual output level of 8,100.

c. In 2012, cyclical unemployment equals 4% - 4.5% = -0.5%, so by Okun’s Law the output is gap is 1%. This implies that real GDP is 1% larger than potential GDP, so real GDP must equal 8,282 (= (1.01)(8200)).

d. In 2013, the output gap is 2% since real GDP is 2% above potential GDP. Using Okun’s law, this implies that cyclical unemployment is –1%. Since the natural unemployment rate is 5%, actual unemployment is 4%.

Problem 5