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Equilibrium GDP and Prices - Recessionary Gap

幫考網(wǎng)校2020-08-05 18:55:54

In an economy, equilibrium GDP refers to the level of output where the aggregate demand (AD) equals the aggregate supply (AS) at the prevailing price level. However, in a recessionary gap, the equilibrium GDP is lower than the potential GDP due to a deficiency in aggregate demand.

A recessionary gap occurs when the aggregate demand falls short of the aggregate supply, resulting in a decline in economic activity, output, and employment. This situation arises when consumers and businesses reduce their spending, leading to a decrease in the demand for goods and services.

As a result, firms reduce their production and employment levels, leading to a decline in the aggregate supply. The lower output and employment levels lead to a decline in the income and purchasing power of households, further reducing demand and supply.

In a recessionary gap, the equilibrium GDP is below the potential GDP, and the economy operates below its full capacity. This situation leads to a fall in prices as firms reduce their prices to stimulate demand and clear their inventories. The lower prices, in turn, lead to a decline in the inflation rate, which may turn into deflation if the recessionary gap persists for an extended period.

To close the recessionary gap and restore the equilibrium GDP, the government and the central bank may adopt expansionary fiscal and monetary policies, respectively. These policies aim to increase aggregate demand by boosting government spending, cutting taxes, lowering interest rates, and increasing the money supply. The increased demand stimulates production and employment, leading to a rise in the equilibrium GDP and prices.