Principles of Macroeconomics / Unit 8 MAC 0723 worked example, 60 to 90 seconds
Gap or No Gap?
The idea
Compare equilibrium real GDP with potential GDP and name the gap, then check the labor market agrees. Output below potential is a recessionary gap, and unemployment should be above the natural rate. Output above potential is an inflationary gap, and unemployment should be below it. Output at potential is neither, and unemployment sits at the natural rate. The two readings always match, because employment and output move together, so a question that gives you one lets you state the other.
In practice
Worked example: potential GDP is twenty trillion and equilibrium output is nineteen. That is a recessionary gap of one trillion, and unemployment is above the natural rate. Second case: equilibrium output is twenty point five trillion against the same potential, an inflationary gap of half a trillion, with unemployment below the natural rate and unable to stay there.
Where people slip
The word inflationary describes pressure, not a measured inflation rate. An economy can have an inflationary gap while reported inflation is still low, because the pressure takes time to reach prices.
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