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In: Economics

Using diagrams and the short-run AD-AS model, show the three short-run equilibrium states of the economy...

Using diagrams and the short-run AD-AS model, show the three short-run equilibrium states of the economy and illustrate (i) a recessionary gap, (ii) an inflationary gap, and (iii) full employment equilibrium.

Solutions

Expert Solution

(i) a recessionary gap : This happens when there is a negative output gap where actual GDP is less than potential GDP. This implies that short run equilibrium occurs to the left of the long run equilibrium. This is shown below where AD and SRAS meet at an equilibrium which is to the left of long run equilibrium where LRAS and AD meet.

(ii) an inflationary gap : This happens when there is a positive output gap where actual GDP is greater than potential GDP. This implies that short run equilibrium occurs to the right of the long run equilibrium. This is shown below where AD and SRAS meet at an equilibrium which is to the right of long run equilibrium where LRAS and AD meet.

(iii) full employment equilibrium : This happens when actual GDP is s equal to potential GDP. This implies that short run equilibrium coincides the long run equilibrium. This is shown below where AD and SRAS meet at an equilibrium which coincides the long run equilibrium where LRAS and AD meet.

Rahul Sunny answered 10 months ago
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