Question

2. According to chapter 10 of the lectures, every society or economy has a potential output also called natural rate of output or full-employment rate of output or long-run aggregate supply. What factors determine the size of an economy’s potential output?

3. Societies don’t always produce their potential output level in the short run. Sometimes they might have an expansionary gap and sometimes a recessionary gap.

a. What is an expansionary gap?

b. What is a recessionary gap?

Answer 1

a) The level of technology that the economy have, the labor force and the human resource in the economy and the amount of capital that is there is the economy decides the potential output in the economy.

b) the expansionary gap is the situation when the short run equilibrium in the economy is at the right side of the LRAS curve and the economy is producing more than the potential output in the market. this is inflationary in the market.

recessionary gap in the market is when the short run equilibrium in the market is at the left side of the LRAS curve and the economy is consuming below the potential output , at this point the demand is low and price fall.