Post on 20-Jan-2015
description
Recessionary and Inflationary Gaps and
supply shocks
It is very rare for a country’s actual output to equal its potential output
- Think back to the PPC - does it seem likely that an economy is going to be operating at its capacity level?
- or is it more common to operate somewhere below
the line?
Recessionary Gap
The amount by which equilibrium output falls short of potential output
Here :SRAS = short run aggregate supply
LRAS = long run aggregate supply
AD = aggregate demand
- this economy is currently producing at the point of equilibrium but could be producing at capacity
output as indicated at the green line.
This, therefore, would simply be the opposite of the recessionary gap:
Inflationary gap
Inflationary gap = the amount by which equilibrium output exceeds potential output.
But... How does an economy operate above potential output
Inflationary gap
here employment may be above the “full employment” level of approx. 5%.at the same time resources may be being used beyond capacity levels.
- that is - no fields left fallow, no renewal measures being taken, etc.
effect of these gaps?
When these situations occur it is necessary for the government and/or banking system to step in and take the appropriate actions.
these actions will work to bring the economy back as close as possible to the capacity level.
supply shock
A drastic change in supply that results in an equally drastic change in prices throughout the economy.