through periods of fl uctuations in real GDP, employment,
and the price level. Although they have certain phases in
common—peak, recession, trough, expansion—business
cycles vary greatly in duration and intensity.
2. Although economists explain the business cycle in terms of
underlying causal factors such as major innovations, productivity
shocks, money creation, and fi nancial crises, they generally
agree that changes in the level of total spending are the
immediate causes of fl uctuating real output and employment.
3. The business cycle affects all sectors of the economy,
though in varying ways and degrees. The cycle has greater
effects on output and employment in the capital goods and
durable consumer goods industries than in the services and
nondurable goods industries.
4. Economists distinguish between frictional, structural, and
cyclical unemployment. The full-employment or natural
rate of unemployment, which is made up of frictional
and structural unemployment, is currently between 4 and
5 percent. The presence of part-time and discouraged workers
makes it diffi cult to measure unemployment accurately.
5. The GDP gap, which can be either a positive or a negative
value, is found by subtracting potential GDP from actual
GDP. The economic cost of unemployment, as measured
by the GDP gap, consists of the goods and services forgone
by society when its resources are involuntarily idle. Okun’s
law suggests that every 1-percentage-point increase in unemployment
above the natural rate causes an additional
2 percent negative GDP gap.
6. Infl ation is a rise in the general price level and is measured
in the United States by the Consumer Price Index (CPI).
When infl ation occurs, each dollar of income will buy fewer
goods and services than before. That is, infl ation reduces
the purchasing power of money.
7. Unemployment rates and infl ation rates vary widely
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