Chapter 10- Short-Term Economic Fluctuations

·      Business cycles- short-term fluctuations in GDP and other variables

·      Recession (or contraction)- a period in which the economy is growing at a rate significantly below normal

·      Depression- a particularly severe or protracted recession

·      Peak- the beginning of a recession; the high point of economic activity prior to downturn

·      Trough- the end of a recession; the low point of economic activity prior to a recovery

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

·      Boom- a particularly strong and protracted expansion

·      Potential output, Y* (or potential GDP or full employment output)- the maximum sustainable amount of output (real GDP) that an economy can produce

·      Output gap- the difference between the economy’s actual output and its potential output, relative to potential output, at a point in time

where a negative output gap is a recessionary gap and a positive output gap is an expansionary gap

·      Recessionary gap- a negative output gap, which occurs when potential output exceeds actual output (Y < Y*)

·      Expansionary gap- a positive output gap, which occurs when actual output is higher than potential output (Y > Y*)

·      Natural rate of unemployment (u*)- the part of the total unemployment rate that is attributable to frictional and structural unemployment; equivalently, the unemployment rate that prevails when cyclical unemployment is zero, so that the economy has neither a recessionary nor an expansionary output gap

where a negative value means there is an expansionary gap and a positive value means there is a recessionary gap

·      Okun’s law- each extra percentage point of cyclical unemployment is associated with about a 2 percent widening of a negative output gap, measured in relation to potential output

If Y* (potential output) growth is slowing down, then the government promotes S-I, technological innovation, and human capital formation.


If actual output is just not equal to Y*, then government should influence planned aggregate expenditure.