Question

The situation where the equilibrium level of real GDP falls short of potential GDP is known as
1. Recessionary gap
2. Inflationary gap
3. Demand-side inflation
4. Supply-side inflation

Answer 1

Correct Answer - Option 1 : Recessionary gap

The correct answer is the Recessionary gap.

• A recessionary gap, or contractionary gap, is a macroeconomic term used when a country's real gross domestic product (GDP) is lower than its GDP at full employment.
• A recessionary gap, or contractionary gap, occurs when a country's real GDP is lower than its GDP at full employment.
• Recessionary gaps close when real wages return to equilibrium, and the quantity of labor demanded equals the quantity supplied.
• Policymakers may choose to implement a stabilization policy to close the recessionary gap and increase real GDP.
• Essentially, a recessionary gap refers to the difference between actual and potential production in an economy, with the actual being lower than the potential, which puts downward pressure on prices in the long run.
• These gaps are evident during an economic downturn and are associated with higher unemployment numbers.

• Significant reductions in economic activity for several months will indicate a recession.
• During periods of recession, companies will often pull back on spending, creating a gap from the contraction in the business cycle.
• In the period leading up to a recession, there is often a significant reduction in consumer expenditure or investment due to a decrease in the take-home pay of workers.
• When production levels fluctuate, prices change to compensate.
• This price change is considered an early indicator that an economy is moving into a recession and may lead to less favorable exchange rates for foreign currencies.