RECESSIONARY AND INFLATIONARY GAPS

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Recessionary gap

If real GDP < Potential real GDP (full employment GDP), then a recessionary gap exist. At the same time: Unemployment rate > natural rate of unemployment. Since more job seekers are in the market, they tend to settle with a lower wage. Lower wage will lower the AS curve and causing the price to decrease. Lower price will increase consumption. This process will continue until the economy reaches the long run equilibrium (potential real GDP).

If the potential GDP is at 700, the following graph presented a recessionary gap between SR equilibrium and the LRAS curve.

Inflationary gap

If real GDP > Potential real GDP (full employment GDP), then an inflationary gap exist. At the same time: Unemployment rate < natural rate of unemployment. Since job seekers are less than job openings in the market, employers are forced to raise the wage to attract new workers. High wage will decrease the AS, and raise the price. Higher price will lower consumption. This process will repeat until the long run equilibrium is reached.

If the potential GDP is at 500, the following graph presented an inflationary gap between SR equilibrium and the LRAS curve.

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