ECON10003 Lecture Notes - Lecture 7: Unemployment, Output Gap, Potential Output
19 Jun 2018
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WEEK 4 MACROECONOMICS
Recession: Occurs when real GDP has a fall and then followed by a recovery as real GDP increases and surpasses the previous
peak. “Technical recession”- real GDP falls for two successive quarters. It is a “market slow-down in GDP growth”, this means a
recession can occur when real GDP is growing, it is just not growing at a rate as fast as the long term average or trend rate. The
slowing can be associated with a rise in unemployment.
The Classical Cycle and the Growth Cycle are two GDP criteria can be used to identify and time recessions. Identifies classical
recession by using the level of real GDP. The Classical Cycle shows peaks and troughs which are associated with contractions
(downwards trends) and expansions (upwards trends). The Growth Cycle is identified according to whether the actual rate of GDP
growth is significantly different form the long term average. Level of real GDP does not have to fall before a recession is
identified.
Recession and unemployment: As unemployment is the economic variable most closely affecting individual and family material
well-being, sometimes it is more appropriate to define a recession in terms of change in the unemployment rate rather than real
GDP. Unemployment is lagged by approx. 24 months, after which time there will be a change in GDP.
Business Cycle: Potential output long run average or trend level of output, or when inputs are being used at “normal” rates of
usage. Periods in which actual output is either above or below this trend level are the business cycle.
The “Classical” Business Cycle
Here, y* indicates in any period the level of real GDP consistent with the economy’s long run growth rate.
Output gap: Measures percentage deviation of actual real GDP from potential real GDP. Symbol y for actual GDP and y* for
potential output.
Expansionary gap: output gap is +ve: y > y*. Actual output above potential or long run trend output.
Contractionary gap: output gap is -ve: y < y*. Actual output below potential or long run trend output.
Natural rate of unemployment (u*) = frictional unemployment + structural unemployment. OR rate of unemployment when
there is no cyclical employment. Cyclical employment refers to the deviations of the actual unemployment rate around the natural
rate.
u- actual unemployment rate
u*- natural rate (unemployment occurring when output is at its potential level (y=y*)
Cyclical unemployment (u-u*). The difference between the actual and the natural rate of unemployment.
The production function says output is produced by inputs, so as y falls below y*, employment falls.
Okun’s Law: Systematic relation b/w the output gap and cyclical unemployment.
Where beta has been estimated recently in the US at 2 and in Aus. Equal to 1.8 (IMF).
The law enables predictions to be made concerning what will happen to unemployment if output deviates from its potential level
and about how much output is lost (compared w/ potential output) if unemployment rises above natural rate.
This version of Okun’s law is commonly known as the “gap version”. It related differences in the actual unemployment rate and
the natural rate, to the gap between actual output and potential output. Neither variable is directly observable and so judgements
about their values must be made.
The law can also be expressed in a different form referred to as the difference or growth rate form. This is derived from
manipulation of the gap version. Assumptions are that the natural rate of unemployment is constant.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Recession: occurs when real gdp has a fall and then followed by a recovery as real gdp increases and surpasses the previous peak. Technical recession - real gdp falls for two successive quarters. It is a market slow-down in gdp growth , this means a recession can occur when real gdp is growing, it is just not growing at a rate as fast as the long term average or trend rate. The slowing can be associated with a rise in unemployment. The classical cycle and the growth cycle are two gdp criteria can be used to identify and time recessions. Identifies classical recession by using the level of real gdp. The classical cycle shows peaks and troughs which are associated with contractions (downwards trends) and expansions (upwards trends). The growth cycle is identified according to whether the actual rate of gdp growth is significantly different form the long term average.
