Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium

Review these sections, which show graphically recessionary and inflationary gaps and relates them to the labor market. Various policy choices are also discussed that address issues in the economy that result from these gaps.


Learning Objectives

  1. Explain and illustrate graphically recessionary and inflationary gaps and relate these gaps to what is happening in the labor market.
  2. Identify the various policy choices available when an economy experiences an inflationary or recessionary gap and discuss some of the pros and cons that make these choices controversial.

The intersection of the economy's aggregate demand and short-run aggregate supply curves determines equilibrium real GDP and price level in the short run. The intersection of aggregate demand and long-run aggregate supply determines its long-run equilibrium. In this section we will examine the process through which an economy moves from equilibrium in the short run to equilibrium in the long run.

The long run puts a nation's macroeconomic house in order: only frictional and structural unemployment remain, and the price level is stabilized. In the short run, stickiness of nominal wages and other prices can prevent the economy from achieving its potential output. Actual output may exceed or fall short of potential output. In such a situation the economy operates with a gap. When output is above potential, employment is above the natural level of employment. When output is below potential, employment is below the natural level.

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