Question

What does it mean to say that the economy is in a recessionary gap? In an inflationary gap? In long-run equilibrium?

Short answer

A recessionary gap refers to the situation when the economy's actual output is less than its potential output, indicating a downturn or recession. An inflationary gap is when the economy's actual output exceeds its potential, leading to increased inflation. Long-run equilibrium describes a state in which the actual output equals the potential output, and there is stability in economic growth and employment.

Step-by-step solution

Understand the Terms

A recessionary gap occurs when the actual aggregate output is lesser than the potential output. On the other hand, an inflationary gap refers to when actual output exceeds potential output. Long-run equilibrium is the state where the actual output is equal to the potential output, and there is full employment in the economy without inflation or recession.

Contextualize: Recessionary Gap

In other words, a recessionary gap is when the resources of an economy (like labor and capital) are under-utilized due to low demand. This suggests an economy in a recession or downturn, with high unemployment and reduced consumer and business spending.

Contextualize: Inflationary Gap

Meanwhile, an inflationary gap implies an economy is overheated, with inflation increasing and demand exceeding supply. This often leads to higher prices for goods and services, as demand is greater than the economy's ability to produce.

Contextualize: Long-run Equilibrium

Lastly, in a state of long-run equilibrium, the economy's actual and potential output are equal, and inflation is stable. This indicates stable economic growth and full employment.