Chapter 29 _ Business Cycles, Unemployment, and Inflation _ ECON 2020.pdf - \u201c\u200bOur goal in this chapter is to examine the concepts terminology and

Chapter 29 _ Business Cycles, Unemployment, and Inflation _ ECON 2020.pdf

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Our goal in this chapter is to examine the concepts, terminology, and facts relating to macroeconomic instability. Specifically, we want to discuss the business cycle, unemployment, and inflation. The concepts discussed are extremely important for understanding subsequent chapters on economic theory and economic policy.” 29.1 [The Business Cycle]: Describe the business cycle and its primary phases. The long-run trend of the U.S. economy is one of economic growth, as stylized by the upsloping line labeled “Growth Trend” in Figure 29.1. But growth has been interrupted by periods of economic instability usually associated with business cycles . Business cycles are alternating rises and declines in the level of economic activity, sometimes over several years. Individual cycles (one “up” followed by one “down”) vary substantially in duration and intensity. At a peak , such as the middle peak shown in Figure 29.1, business activity has reached a temporary maximum. Here the economy is near or at full employment and the level of real output is at or very close to the economy’s capacity. The price level is likely to rise during this phase. A recession is a period of decline in total output, income, and employment. This downturn, which lasts 6 months or more, is marked by the widespread contraction of business activity in many sectors of the economy. Along with declines in real GDP, significant increases in unemployment occur. In the trough of the recession or depression, output and employment “bottom out” at their lowest levels. The trough phase may be either short-lived or quite long. A recession is usually followed by a recovery and expansion , a period in which real GDP, income, and employment rise. At some point, the economy again approaches full employment. If spending then expands more rapidly than does production capacity, prices of nearly all goods and services will rise. In other words, inflation will occur. A key issue in macroeconomics is why the economy sees business cycle fluctuations rather than slow, smooth growth. In terms of Figure 29.1, why does output move up and down rather than just staying on the smooth growth trend line? Economists have developed several possible explanations. But before turning to them, recall that in Chapter 26 we explained that these theories are founded on the idea that fluctuations are driven by shocks—unexpected events that individuals and firms may have trouble adjusting to. Also recall that short-run price stickiness is widely believed to be a major factor preventing the economy from rapidly adjusting to shocks. With prices sticky in the short run, price changes cannot quickly equalize the quantities demanded of goods and services with their respective quantities supplied
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after a shock has happened. Instead, the economy is forced to respond to shocks in the short run primarily through changes in output and employment rather than through changes in prices.
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