The business cycle Chapter 6-2

The Business Cycle The business cycle is the short-run alternation between economic downturns and economic upturns. A depression is a very deep and prolonged downturn. Recessions are periods of economic downturns when output and employment are falling. Expansions, sometimes called recoveries, are periods of economic upturns when output and employment are rising.

How are recessions and expansions defined? There is no exact definition! Two consecutive quarters (6months) of falling/rising Ag Output rule is used This is to prevent misclassifying hiccups in the economy as recession or expansion.

The Business Cycle What happens during a business cycle, and what can be done about it? the effects of recessions and expansions on unemployment; the effects on aggregate output; and the possible role of government policy.

Employment and Unemployment Employment is the number of people working in the economy. Unemployment is the number of people who are actively looking for work but aren’t currently employed. The labor force is equal to the sum of employment and unemployment.

Employment and Unemployment Discouraged workers are non-working people who are capable of working but are not actively looking for a job. Underemployment is the number of people who work during a recession but receive lower wages than they would during an expansion due to smaller number of hours worked, lower-paying jobs, or both. The unemployment rate is the ratio of the number of people unemployed to the total number of people in the labor force, either currently working or looking for jobs.

Underemployment

The Unemployment Rate and Recessions Since 1948 The unemployment rate normally rises during recessions and falls during expansions. As shown here, there were large fluctuations in the U.S. unemployment rate during the period after World War II. Shaded areas show periods of recession; unshaded areas are periods of expansion. Over the entire period from 1948 to 2004, the unemployment rate averaged 5.6%. Source: Bureau of Labor Statistics; National Bureau of Economic Research.

The Effects of Recessions and Expansions on Unemployment and Aggregate Output: In general, the unemployment rate rises during recessions and falls during expansions. It moves in the direction opposite to aggregate output, which falls during recessions and rises during expansions.

What is this Aggregate Output? Real GDP is the actual number used to measure Aggregate Output Aggregate Output rise during Aggregate Output falls during Expansion Recession

Growth in Aggregate Output, 1948–2004 Panel (a) above, shows the annual rate of growth of U.S. aggregate output from 1948 to 2004. Although output grew in most years, with an average growth rate of 3.3%, the actual growth rate fluctuated with the business cycle, and output actually declined in some years. Real GDP is a measure of aggregate output, the output of the economy as a whole.

U. S. Business Cycles 20 10 –10 –20 ‘90 ‘80 1860 ‘70 1900 ‘10 ‘20 ‘30 –10 –20 ‘90 ‘80 1860 ‘70 1900 ‘10 ‘20 ‘30 ‘40 ‘50 ‘60 2000 World War II World War I Recovery of 1895 Civil War Korean War Vietnam War Panic of 1893 Panic of 1907 Great Depression McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Growth in Aggregate Output, 1948–2004 Panel (b) shows the same data presented in a different form: it shows real GDP from 1948 to 2004. From it we see that given a sufficiently long period of time to be independent of the business cycle, real GDP has grown substantially.

Taming the Business Cycle Policy efforts undertaken to reduce the severity of recessions are called stabilization policy. One type of stabilization policy is monetary policy, changes in the quantity of money or the interest rate. The second type of stabilization policy is fiscal policy, changes in tax policy or government spending, or both. Although recessions are temporary phenomena, they produce a considerable amount of economic pain for an economy’s members. So one of the key missions of macroeconomics is to understand why recessions happen, and what, if anything, can be done about them.

ECONOMICS IN ACTION: Has progress in macroeconomics made the economy more stable? Answer: “Sort of” Clearly, nothing like the Great Depression ─ the huge surge in unemployment that dominates the figure─has happened since. But economists who argued during the 1960s that the business cycle had been completely tamed were proved wrong by severe recessions in the 1970s and early 1980s.