Question

Figure 10-3 Potential Potential GDP GDP Real Expenditure Price Level C+I+X-IM) 7 5,500 6,500 Real GDP (billions of dollars per year) (a) 5,500 6,500 Real GDP (billions of dollars per year) (6) In Figure 10-3, both graphs (a) and (b) indicate that the economy is experiencing an) a. recessionary gap of RE. O b. inflationary gap of RG. O crecessionary gap of RG. d. inflationary gap of RE.

Answer 1

Answer

Equilibrium occurs when AD and AS intersects. We can see from second graph that S and D intersects at point E and At point E Real GDP > Potential Output and hence there is an inflationary gap. This inflationary gap = Real GDP - Potential GDP = RE.

We can see from first graph that goods market Equilibrium occurs when Y = AE where Y = Real GDP and AE = Aggregate expenditure. We can see from first graph Y = AE at point E. At point E, Real GDP > Potential Output and hence there is an inflationary gap. This inflationary gap = Real GDP - Potential GDP = RE.

Hence, the correct answer is (d) inflationary gap of RE.