Question

a) What is meant by a “recessionary gap?” (b) What are the two main causes of a recessionary gap? Explain how each of these events cause unemployment. please explain in 200 words.

Answer 1

Answer:-

a) A recessionary gap is a condition in which the Real GDP that the economy is producing is less than the Natural Real GDP and the unemployment rate is greater than the natural unemployment rate. In the recessionary gap, the short run equilibrium real GDP is less than the natural real GDP.

b) The two main causes of a recessionary gap are

·         Fall in aggregate demand

·         Fall in aggregate supply

In both cases, the desired output of the economy is below its potential level. Then the firm must produce its full employment level to keep profit positive. Then in both cases the firm layoff some workers and decreases its production to the desired level. As a result, the employment falls below full employment and unemployment results.

Solutions for a Recessionary Gap

The expansionary fiscal policy is designed to stimulate the economy during or anticipation of a business-cycle contraction. This is accomplished by increasing aggregate expenditures and aggregate demand through an increase in government spending (both government purchases and transfer payments) or a decrease in taxes. Expansionary fiscal policy leads to a larger government budget deficit or a smaller budget surplus.

In general, expansionary fiscal policy works through the two sides of the government's fiscal budget -- spending and taxes. However, it's often useful to separate these two sides into three specific tools -- government purchases, taxes, and transfer payments.