Question

1. When actual output (where AD and SRAS intersect) is less than LRAS, this is a(n) _____ gap. (inflationary or recessionary?)

2. A inflationary gap is when actual output (where AD and SRAS intersect) is _____ less than  LRAS. (greater than, or less than?)

3. A fall in government purchases will cause _____ (aggregate demand/short run aggregate supply) to _____ (shift in/shift out).

Answer 1

1. A recessionary gap occurs when the actual real GDP is fall short of the potential level of output, the potential output is at the LRAS level. At this level the real GDP is lower than what is expected so there would an increase in the unemployment rate , the recessionary gap occurs due to an inefficient allocation of resources or due to a negative demand shock , the government can eliminate the recessionary gap by introducing an expansionary fiscal policy.

Ans: Recessionary gap.

2. An inflationary gap occurs when the actual real GDP is greater than the potential level of output, the inflationary gap obviously is the result of excess demand. The government can tackle this problem by introducing a contractionary fiscal policy, the contractionary fiscal policy is either an increase in the tax or decrease in the government spending, these actions will reduce the excess purchasing power in the economy and will bring back the economy to full employment level of output.

Ans: Inflationary gap.

3. A fall in the government purchase is a part of the contractionary fiscal policy, this will reduce the employment opportunities in the economy so the income of the people will decrease. So the people consume less and since consumption is a component of the aggregate demand the aggregate demand will decrease and this is shown by a leftward shift of the aggregate demand curve.

Ans: Aggregate demand ; shift out.