AS OUTPUT FALLS, UNEMPLOYMENT RISES

Changes in the economy’s output of goods and services are strongly correlated with changes in the economy’s utilization of its labor force. In other words, when real GDP declines, the rate of unemployment. This fact is hardly surprising: When firms choose to produce a smaller quantity of goods and services, they layoff workers, expanding the pool of unemployed.

Figure 1 A Look at Short-Run Economic Fluctuations

This figure shows real GDPin panel (a), investment spending in panel (b), and unemployment in panel (c) for the U.S. economy using quarterly data since 1965. Recessions are shown as the shaded areas. Notice that real GDP and investment spending decline during recessions, while unemployment rises.

(a) Real GDP

(a) Real GDP

(b) Investment Spending

(b) Investment Spending

(e) Unemployment Rate

(e) Unemployment Rate

Panel (c) of. Figure 1 shows the unemployment rate in the U.S. economy since 1965. Once again, recessions are shown as the shaded areas in the figure. The figure shows clearly the impact of recessions on unemployment. In each of the recessions, the unemployment rate rises substantially. When the recession ends and real GDP starts to expand, the unemployment rate gradually declines. The unemployment rate never approaches zero; instead, it fluctuates around its natural r.ate of about 5 or 6 percent.