explain the relationship between real GDP and potential GDP and between the unemployment rate and the...

explain the relationship between real GDP and potential GDP and between the unemployment rate and the natural unemployment rate as the economy moves through a business cycle.

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Expert Solution

Real GDP and Potential GDP

When the economy is at full employment, real GDP equals potential GDP; so actual real GDP is determined by the same factors that determine potential GDP.
Real GDP can exceed potential GDP only temporarily as it approaches and then recedes from a business cycle peak. So potential GDP is the sustainable upper limit of production.
Real GDP fluctuates around potential GDP, which means that on the average over the business cycle, real GDP equals potential GDP.

Actual Unemployment Rate and Natural Unemployment Rate

The natural rate of unemployment is the unemployment rate at full employment.
When the economy is at full employment, real GDP is equal to potential real GDP. By contrast, when the economy is below full employment, the unemployment rate is greater than the natural unemployment rate and real GDP is less than potential. Finally, when the economy is above full employment, then the unemployment rate is less than the natural unemployment rate and real GDP is greater than potential.
When the actual unemployment rate is higher than the natural unemployment rate, the inflation rate decreases; when the actual unemployment rate is lower than the natural unemployment rate, the inflation rate increases.

Rahul Sunny answered 1 year ago

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