Question

What is a recessionary expenditure gap? An inflationary expenditure gap? Which is associated with a positive GDP gap? A negative GDP gap?

Short answer

The recessionary expenditure gap is the difference between potential expenditure and actual expenditure.

When the actual expenditure becomes more than the full employment expenditure, the excess spending is the inflationary expenditure gap.

The inflationary gap is associated with a positive GDP gap.

The recessionary expenditure gap reflects a negative GDP gap.

Step-by-step solution

Step 1. Meaning of recessionary expenditure gap

A recessionary expenditure gap occurs when the economy cannot meet the full employment expenditure, and the actual GDP stabilizes at a lower level.

The aggregate expenditure at full employment (AE_f) produces Y_f level of potential GDP. The actual expenditure (AE) lies below the full employment expenditure delivering Y level of GDP.

The downward vertical distance between the actual expenditure and full employment expenditure is the recessionary expenditure gap.

Step 2. Meaning of inflationary expenditure gap

An inflationary expenditure gap occurs when the economy operates above the full employment level. It is the result of demand-pull inflation. When the demand rises beyond the full employment level, the output becomes constant; only prices keep rising, increasing aggregate expenditure.

The full employment expenditure (AEf) produces a Yf level of potential GDP that is less than the Y level of GDP produced by the actual expenditure (AE). The vertical upward distance between the actual and full employment expenditures is the inflationary expenditure gap.

Step 3. Positive GDP gap

A GDP gap is equal to actual GDP minus the potential GDP. In the inflationary expenditure gap, actual GDP exceeds the full employment level GDP.

GDP gap = Actual GDP – Potential GDP

Actual GDP > Potential GDP

GDP gap > 0

Therefore, inflationary expenditure is associated with a positive GDP gap.

Step 4. Negative GDP gap

Since the GDP falls below the full employment level during the recession, the actual GDP falls short of the potential GDP.

GDP gap = Actual GDP – Potential GDP

Actual GDP > Potential GDP

GDP gap < 0

Therefore, a recessionary expenditure gap is associated with a negative expenditure gap.