Question

a. Define a recessionary gap. Draw the LRAS curve to show a recessionary (contractionary gap) gap. b. Show the condition of the labor (and other resource) markets. Draw the labor market diagram next to the AS/AD diagram. c. Show and explain how a recessionary (contractionary) gap is closed using a nonintervention policy. SRAS, Price Level Ø 6 10 7 8 9 Real GDP d. e. Draw the LRAS curve to show an inflationary (expansionary) gap. What is a stabilization policy? SRAS, Price Level 10 7 8 9 Real GDP f. Show and explain how an inflationary (expansionary) gap is closed using a stabilization policy.

Answer 1

As per the HOMEWORKLIB POLICY, answering the first four parts.

2.

LRAS CRAS, LABOR MARKET NADI Your Real GOP Recessionary 4 LX in Gap Employm _enty Recessionary Gap LRAS SRASI VSRAS, Real GDP LRAS SRAS, SAD, Real GDP Expansionary Cap.

a.

Recessionary gap is the gap where the actual level of output is less than the potential level of output. Due to this gap, output is low and unemployment is high.

Potential level of output is given by the long run aggregate supply curve (LRAS). LRAS curve is shown in the part a figure as a vertical line. The gap Y1-Yp is called the recessionary gap.

b.

In the labor market, wage rises to w2 and the employment decreases from L* to L1 and the gap L*-L1 is called recessionary gap. Shown in part a. figure.

c.

A recessionary gap can be closed by a non-intervention policy. Automatic stabilizers will work which will shift the short run aggregate supply to right from SRAS1 to SRAS2. These automatic stabilizers may include unemployment benefit transfers or increase in insurance premium paid by firms.

As a result, the new supply curve intersect the old demand curve at point E1. Economy is at potential level of output and the gap is closed.

d.

Graph d. shows vertical LRAS curve. The distance Yp-Y1 is called expansionary gap where the Potential Ouput Yp < Actual Output Y1

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