Recessionary Gap

Definition

A recessionary gap refers to the difference between the actual level of real GDP and the potential level of real GDP when the economy is in a recession. It represents the shortfall in output and employment compared to the economy's productive capacity.

5 Must Know Facts For Your Next Test

1. A recessionary gap occurs when the actual level of real GDP falls below the economy's potential GDP.
2. The recessionary gap represents the underutilization of an economy's productive capacity and leads to higher unemployment.
3. Keynesian economic theory suggests that the recessionary gap can be addressed through expansionary fiscal and monetary policies to stimulate aggregate demand.
4. The neoclassical perspective views the recessionary gap as a temporary disequilibrium that will self-correct through market forces and price adjustments.
5. Reducing a recessionary gap is a key objective of stabilization policies aimed at promoting full employment and economic growth.

Review Questions

• Explain how the recessionary gap is related to the concept of aggregate demand in Keynesian analysis.
  • In Keynesian analysis, a recessionary gap arises when aggregate demand in the economy is insufficient to fully utilize the economy's productive capacity. The recessionary gap represents the shortfall between actual GDP and potential GDP, which is caused by a deficiency in aggregate demand. Keynesian economists believe that government intervention through expansionary fiscal and monetary policies can help increase aggregate demand and close the recessionary gap, thereby promoting full employment and economic growth.
• Describe the Keynesian perspective on how market forces address the recessionary gap.
  • The Keynesian perspective suggests that market forces alone are not sufficient to address a recessionary gap. Keynesian economists believe that the economy can experience prolonged periods of underemployment and output below potential due to sticky prices and wages, as well as the inability of the economy to self-correct through the adjustment of interest rates and prices. Therefore, Keynesian theory advocates for active government intervention, such as fiscal and monetary policies, to stimulate aggregate demand and close the recessionary gap.
• Analyze how the neoclassical perspective on the building blocks of economic analysis differs from the Keynesian view in addressing the recessionary gap.
  • The neoclassical perspective on the building blocks of economic analysis, as outlined in Topic 26.1, differs from the Keynesian view in addressing the recessionary gap. Neoclassical economists believe that the economy will naturally return to its potential GDP level through the adjustment of prices and wages, and that government intervention is not necessary. They view the recessionary gap as a temporary disequilibrium that will self-correct through the operation of market forces. In contrast, the Keynesian perspective emphasizes the need for active government policies to stimulate aggregate demand and close the recessionary gap, as the economy may not automatically return to full employment equilibrium.

Related terms

Aggregate Demand: The total demand for all goods and services in an economy at a given time and price level.

Potential GDP: The highest level of real GDP that an economy can sustain over the long run without generating excessive inflation.

Actual GDP: The total value of all final goods and services produced within a country's borders in a given time period.