1) There are four phases of the business cycle: recession, depression, peak, and trough. Recessions are periods of economic contraction while expansions include booms. 2) Business cycles cause fluctuations in real GDP and cyclical unemployment. The size of recessions and expansions can be measured by comparing actual output and unemployment to potential output and the natural rate of unemployment. 3) Short-term economic fluctuations are primarily caused by changes in aggregate spending as prices adjust and markets reach equilibrium. Policymakers aim to stabilize the economy by closing output gaps between actual and potential output.

1. ECONOMIC
FLUCTUATIONS
GT01003
Macroeconomics

3. THE ECONOMY IN THE SHORT RUN
Short-Run
Fluctua-
tions
Aggregate
Spending
Monetary
Policy
Inflation
Policy
Analysis

4. LEARNING OBJECTIVES
1. Identify the four phases of the business cycle
2. Symptoms of Business Cycles
3. How we tell whether a particular recession or
expansion is “big” or “small”??
4. Causes of short-term fluctuations

5. FLUCTUATIONS IN US REAL GDP, 1920-2007

6. FOUR PHASES OF BUSINESS CYCLES
 These fluctuations in GDP are known as
business cycles.
 Recession (or contraction) is a period in which the
economy is growing at a rate below normal
 Depression – an extremely severe or protracted
recession is called a depression.
 A peak is the beginning of a recession
 High point of the business cycle
 A trough is the end of a recession
 Low point of the business cycle

7. FOUR PHASES OF BUSINESS CYCLES
 The opposite of a recession is an expansion.
 A particular strong expansion is called a boom.

8. SHORT-TERM ECONOMIC FLUCTUATIONS
 Economists have studied business cycles for at
least a century
 Recessions and expansions are irregular in their length
and severity
 Contractions and expansions affect the entire economy
 May have global impact
 Great Depression of the 1930s was worldwide
 US recessions of 1973 – 1975 and 1981 – 1982
 East Asian slowdown in the late 1990s

9. REAL GDP GROWTH, 1999 – 2004
Canada
Germany
United Kingdom
Japan

10. SYMPTOMS OF BUSINESS CYCLES
 Cyclical unemployment rises sharply during
recessions
 Real wages grow more slowly for those employed
 Promotions and bonuses are often deferred
 New labor market entrants have difficulty finding work
 Production of durable goods is more volatile than
services and non-durable goods
 Cars, houses, capital equipment less stable

11. SYMPTOMS OF BUSINESS CYCLES
 Inflation generally decreases during a recession
 Decreases at other times as well

12. How we tell whether a particular
recession or expansion is
“big” or “small”??

13. OUTPUT GAPS & CYCLICAL UNEMPLOYMENT
 How we tell whether a particular recession or
expansion is “big” or “small”??
 Answer: the deviations of output and
unemployment
 Potential output, Y* , is the maximum sustainable
amount of real GDP that an economy can produce.
 Actual output does not always equal potential
output.

14. OUTPUT GAPS
 Output gap is the difference between potential
output and actual output at a point in time
Output gap = [(Y – Y*)/Y*] x 100%
 Recessionary gap is a negative output gap; Y* > Y
 Expansionary gap is a positive output gap; Y* < Y
 Policymakers consider stabilization policies when
there are output gaps
 Recessionary gaps mean output and employment are
less than their sustainable level
 Expansionary gaps lead to inflation to ration output

15. NATURAL RATE OF UNEMPLOYMENT
 Recessionary gaps have high unemployment rates
 Expansionary gaps have low unemployment rates
 The natural rate of unemployment, u*, is the sum
of frictional and structural unemployment
 Unemployment rate when cyclical unemployment is 0
 Occurs when Y = Y*
 Cyclical unemployment is the difference between
total unemployment, u, and u*
 Recessionary gaps have u > u*
 Expansionary gaps have u < u*

16. CAUSES OF SHORT-TERM
FLUCTUATIONS

17. CAUSES OF SHORT-TERM FLUCTUATIONS
 Output gaps arise for two main reasons
 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 current prices

18.  Output gaps arise for two main reasons
 Changes in total spending at preset prices affects output
levels
 When spending is low, 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
CAUSES OF SHORT-TERM FLUCTUATIONS

19. THE ECONOMIC NATURALIST 10.1: DYNAMIC
PRICING
 Coca-Cola tested machines that could modify
prices according to demand
 Temperature sensors triggered higher prices on hot
days
 Machines could raise prices for periods of high demand
 Justified as a response to consumer demand
 Barriers to flexible pricing
 Sophisticated vending machines increase costs
 Consumers reacted negatively to change in pricing
practices

20. CONCLUSION
Short-Term
Economic
Fluctuations
Business
Cycles
4 Phases of
Business Cycles
Symptoms
Causes
Potential
Output
Output
Gaps
Natural Rate of
Unemployment