Question

The economy’s current level of equilibrium GDP is \(780 billion. The full-employment level of GDP is \)800 billion. The multiplier is 4. Given those facts, we know that the economy faces _______ expenditure gap of ___________.

1. an inflationary; \(5 billion

2. an inflationary; \)10 billion

3. an inflationary; \(20 billion

4. a recessionary; \)5 billion

5. a recessionary; \(10 billion

6. a recessionary; \)20 billion

Short answer

Option (c):a recessionary; $20 billion

Step-by-step solution

Step 1. Meaning of expenditure gap

The expenditure gap arises when there is a difference in the equilibrium level of GDP and full employment GDP. The equilibrium GDP is the actual income or output of the economy. Full employment GDP means the output that could have been produced if the resources were utilized efficiently.

The difference between the two can result in an inflationary( actual GDP>Potential GDP) or a recessionary gap (Potential GDP>actual GDP).

Step 2. Explanation for the correct option

A recessionary expenditure gap occurs when the equilibrium GDP or actual GDP falls short of reaching the point of full employment GDP. The GDP produced is below the potential capacity production of the economy. In such a case, the economy faces the loss of potential GDP.

Here, the equilibrium GDP is less than the potential or full employment GDP. Therefore, the economy experiences a recessionary gap. The difference between the potential GDP and equilibrium GDP is $20 billion (= $800 - $780). Thus, the magnitude of the recessionary gap is $20 billion.