Recessionary Gap

Definition

The recessionary gap refers to the difference between the economy's actual output and its potential output during a recession. It represents the shortfall in real GDP compared to the level of output the economy is capable of producing at full employment and optimal resource utilization.

5 Must Know Facts For Your Next Test

1. The recessionary gap arises when actual real GDP falls short of the economy's potential GDP, indicating underutilization of resources and the presence of a recession.
2. The recessionary gap is associated with a leftward shift in the aggregate demand (AD) curve, leading to a lower equilibrium level of real GDP and higher unemployment.
3. Keynesian economics emphasizes the role of government intervention, through fiscal and monetary policies, to close the recessionary gap and stimulate the economy.
4. The size of the recessionary gap determines the magnitude of the economic downturn and the extent of the required policy response to restore full employment and potential output.
5. Reducing the recessionary gap is a key objective of stabilization policies, as it helps mitigate the negative effects of recessions on employment, income, and overall economic well-being.

Review Questions

• Explain how the recessionary gap is related to the AD/AS model and its incorporation of growth, unemployment, and inflation.
  • The recessionary gap is a central concept in the AD/AS model, which demonstrates how the economy's actual output can fall short of its potential output during a recession. The recessionary gap arises when a leftward shift in the aggregate demand (AD) curve leads to a lower equilibrium level of real GDP, indicating underutilization of resources and the presence of a recession. This gap between actual and potential GDP is associated with higher unemployment and lower inflationary pressures, as the economy operates below its capacity. The AD/AS model highlights the role of the recessionary gap in understanding the dynamics of growth, unemployment, and inflation during economic downturns.
• Describe how the recessionary gap is incorporated into Keynesian analysis of aggregate demand.
  • In Keynesian analysis, the recessionary gap is a key feature of the aggregate demand (AD) framework. Keynesian economists view the recessionary gap as the result of insufficient aggregate demand, where actual real GDP falls short of the economy's potential GDP. This gap represents the underutilization of resources and the presence of a recession. Keynesian analysis emphasizes the role of government intervention, through fiscal and monetary policies, to stimulate aggregate demand and close the recessionary gap. By increasing government spending, reducing taxes, or implementing expansionary monetary policies, policymakers can shift the AD curve to the right, raising the equilibrium level of real GDP and reducing the recessionary gap.
• Evaluate the Keynesian perspective on the role of market forces in addressing the recessionary gap.
  • The Keynesian perspective on the recessionary gap challenges the ability of market forces alone to address the problem. Keynesian economists believe that during a recession, the economy may not automatically return to full employment and potential output due to the presence of sticky prices and wages, as well as the lack of self-correcting mechanisms in the market. They argue that government intervention through fiscal and monetary policies is necessary to stimulate aggregate demand and close the recessionary gap. The Keynesian view emphasizes that market forces may be insufficient to restore full employment, and that active stabilization policies are required to mitigate the negative effects of recessions and promote economic recovery. This perspective highlights the limitations of relying solely on market forces to address the recessionary gap.

Related terms

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

Aggregate Supply: The total quantity of goods and services that firms are willing to sell at different price levels in an economy.

Potential GDP: The level of real GDP that an economy can produce when its factors of production (labor, capital, land, and technology) are fully employed.