1. What is a business cycle?

Business cycles are recurring patterns of ups and downs in real GDP. A typical cycle has four stages: expansion, peak, contraction and trough. During an economic expansion (boom), output, employment, incomes, and prices all rise. A peak is reached, after which economic activity declines. During the contraction (recession) phase, output, employment, and income all drop. If the contraction is severe enough, prices may also decline. The trough marks the end of a contraction and the beginning of new expansion.

2. How is the unemployment rate defined and measured?

The unemployment rate is the percentage of the labor force that is not working. Economists do not include the entire population in the labor force. To be in the U.S. labor force, an individual must be working or actively seeking work.

3. What is the cost of unemployed resources?

The cost of unemployed resources is lost output. Potential real GDP is the level of output that can be produced if all nonlabor resources are fully utilized and unemployment is at its natural rate—that is, if the economy is producing the level of output it can realistically produce. To measure lost output, one subtracts the actual real GDP from potential real GDP. The resulting figure indicates the GDP gap—the cost of unemployed resources.

4. What is inflation?

Inflation is a sustained rise in the average level of prices. This does not mean that all prices will rise. Some may rise and some may fall, but inflation occurs when the average level of prices rises.

5. Why is inflation a problem?

Inflation is not a problem if prices and incomes rise at the same rate. But if incomes rise more slowly than prices, households will not be able to buy as many goods and services as they did before. Unanticipated inflation redistributes income away from those who receive fixed incomes toward those who make fixed expenditures.