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Otherwise known as an expansionary gap, an inflationary gap is the gap between an economy's full-employment real GDP and its real GDP. In other words, the inflationary gap refers to the difference (that is, the gap) between the actual gross domestic product (GDP) and the GDP that would exist if the economy were at full employment (this is also known as the "potential GDP").

In the case of an inflationary gap, the real GDP is higher than the potential GDP. (This is in contrast to a deflationary gap, when the real GDP is lower than the potential GDP.) The real GDP is greater than the potential GDP due to the fact that, when the real GDP increases, the general price level also increases in the long run.

First established by influential economist John Maynard Keynes, the macroeconomic concept of the inflationary gap is applied in order to assess and quantify the pressure of inflation. During the course of the business cycle, it arises when the economy is in the process of expanding. Specifically, they appear when the output of an economy that could potentially be created at full employment (that is, the full-employment real GDP) is less than the equilibrium level of that economy.

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Inflationary Gap | Intelligent Economist

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Otherwise known as an expansionary gap, an inflationary gap is the gap between an economy's full-employment real GDP and its real GDP. In other words, the inflationary gap refers to the difference (that is, the gap) between the actual gross domestic product (GDP) and the GDP that would exist if the economy were at full employment (this is also known as the "potential GDP").

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Explain (using graphs as appropriate) the short-run and long-run equilibrium price level and output level.

Explain (using graphs as appropriate) the response of output, employment, and the price level to an aggregate demand or aggregate supply shock in the short run.

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Economists use the aggregate demand–aggregate supply model to represent the relationship between the price level and aggregate output in an economy and to illustrate how output, employment, and the price level respond to macroeconomic shocks.

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Short-run equilibrium occurs when the aggregate quantity of output demanded and the aggregate quantity of output supplied are equal—i.e., at the intersection of the AD and SRAS curves.

Long-run equilibrium occurs when the AD and SRAS curves intersect on the LRAS—i.e., at the full-employment level of real output.

The short-run equilibrium output can be at the full-employment level of output, above it, or below it, creating positive (i.e., inflationary) or negative (i.e., recessionary) output gaps.

A positive (negative) shock in AD causes output, employment, and the price level to rise (fall) in the short run.

A positive (negative) shock in SRAS causes output and employment to rise (fall) and the price level to fall (rise) in the short run.

Inflation can be caused by changes in aggregate demand (demand-pull) or aggregate supply (cost-push).

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There is always widespread interest in the degree to which the U.S. labor market generates higher pay for workers. A standard measure of wage growth suggests that this expansion is not improving the standard of living of workers, but our analysis reveals that actual wage growth is understated.

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This wk: A recession hits and an employer needs to reduce labor costs. Do they cut wages or fire employees? Next wk: Back to the AD-AS model with the short-run aggregate supply curve. Imagine you're an employer during a recession, and you desperately need to cut labor costs to keep your firm afloat.

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Imagine you're an employer during a recession, and you desperately need to cut labor costs to keep your firm afloat. Are you more likely to cut wages across the board for all employees, or institute layoffs for only some?

While it may seem that wage cuts are the "better" choice, they aren't as common as you might think. Why is that?

To answer that question, this video explores a phenomenon known as " sticky wages."

In other words, wages have a tendency to get "stuck" and not adjust downwards. This occurs even during a recession, when falling wages would help end the recession more quickly.

However, that's not to say that wages cannot adjust downward for an individual during a recession. This can happen, but likely only after an employee has been fired from their initial job, and eventually rehired by a different firm at a lower wage rate.

Back to our original question -- why are employers unlikely to cut wages? A big reason has to do with the effect on morale. Employees may become disgruntled and angry when they experience a nominal wage cut, and become less productive.

An important note here -- notice that we said nominal wage cut, meaning, not adjusted for inflation. If an employee receives a 3% raise in nominal wages, they may remain happy in their current position. But what if inflation is 5%? What does this mean for their real wage? (Hint: For an in depth answer to this question check out our earlier Macroeconomics video on " money illusion.")

Next week we'll return to our discussion on the AD/AS model for a look at how factors such as "sticky wages" affect the economy in the short run.

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Sticky Wages | Marginal Revolution University

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Imagine you're an employer during a recession, and you desperately need to cut labor costs to keep your firm afloat. Are you more likely to cut wages across the board for all employees, or institute layoffs for only some? While it may seem that wage cuts are the "better" choice, they aren't as common as you might think.

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Having a real problem with question 1 in the practice questions at the end of this video. After the initial increase in LRAS, a new curve (SRAS2) is established temporarily reducing inflation and increasing GDP. Next, consumer confidence increases pushing the AD curve up and to the right creating AD2. At this point, the "end point" of the "short-term effects" is at the intersection of SRAS2 and AD2. However, I would have to interpret the increase in AD as being the result of a VELOCITY change. As such, the new long-term equilibrium would be reached by tracing back and DOWNWARD along SRAS2 to.the intersection with LRAS2. This move would result in a DECREASE in inflation as compared to the short-term effect, not an increase. Please respond, as this is driiving me nuts!

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Office Hours: Multiple Shocks with the AD-AS Model | Macroeconomics Videos

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In this video, we review the AD-AS model with three real-world examples. All three scenarios include multiple shocks to the economy. We explore the effects of each scenario on inflation and the fundamental factors of production and we find out what happens to the LRAS, SRAS, and AD curves.

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Excellent video. I wonder, though, if the stickiness of wages and prices in the midst of a downturn can be understood in terms of price controls. It's not a price control imposed by law. Instead it's imposed by norms of society, but the effect is just the same. If this is a sensible way to think of it, should the supply and demand curve analysis follow a price control analysis approach?

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Office Hours: Using the AD-AS Model | Macroeconomics Videos

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Confused about how the aggregate-demand aggregate-supply model works? In this Office Hours video, we'll dive deep into the factors that cause the curves that make up the AD-AS model to shift on the graph and what this model can tell us about the economy.

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In early May 2018, The Wall Street Journal asked professional forecasters to predict when the next recession would begin. Nearly 6 in 10 answered that the next recession will begin sometime in 2020. If so, the current business expansion will have eclipsed the 1991-2001 expansion as the longest on record. Economists and policymakers look at several leading indicators when attempting to predict a slowdown or outright contraction in economic activity. Two stand out: the slope of the yield curve and the direction of the unemployment rate. The purpose of this essay is to ascertain the predictive power of these two economic indicators.

Economists have known for quite some time that yield curve inversions tend to be reliable predictors of business contractions (recessions). ¹ An inversion occurs when the yield on short-term Treasury securities exceeds the yield on long-term Treasury securities. Typically, an inversion occurs when the Federal Open Market Committee (FOMC) is raising its short-term policy rate to counteract rising inflation pressures.

Figure 1 plots the difference between the yield on 10-year Treasury securities and the yield on 3-month Treasury securities at a monthly frequency. This yield spread is one commonly used measure of the slope of the yield curve (also known as the term structure) across time. As Figure 1 shows, yield curve inversions have regularly occurred prior to periods of economic recessions since the 1960s. Recession periods are defined by the National Bureau for Economic Research (NBER) Business Cycle Dating Committee. ²

Some monetary policymakers have become concerned about the recent flattening of the yield curve. ³ In April 2018, the slope of the yield curve averaged 1.11 percent, 0.5 percent (50 basis points) below its long-term expansion average of 1.51 percent (since June 1954). The concern about a further flattening of the yield curve slope, or outright inversion, stems from the possibility that several additional increases in the FOMC's federal funds rate target will not be accompanied by increases in the 10-year interest rate.

In contrast to a narrowing of the spread between short- and long-term Treasury yields, a low unemployment rate usually suggests strengthening economic growth. On June 1, 2018, the Bureau of Labor Statistics reported that the unemployment rate (after falling persistently) measured 3.8 percent in May 2018. This is only the third economic expansion in the past eight (current included) that has registered an unemployment rate below 4 percent (see table). Does the low unemployment rate suggest a different outlook from the narrowing yield spread?

Historically, a trough in the unemployment rate also tends to be a reliable predictor of a business recession. This fact can be visually verified in Figure 2, which plots the civilian unemployment rate for all persons ages 16 and over since June 1954. As seen in Figure 2, the unemployment rate tends to reach a trough shortly before an economic recession. Once the recession begins, unemployment rises sharply. But is an unemployment rate trough a more reliable signal of a pending recession than a yield curve inversion?

The table examines the leading-indicator properties of unemployment rate troughs (left side) and yield curve inversions (right side) since 1969. In each instance, the month of occurrence is compared with the business expansion peak, as determined by the NBER. Since there were no yield curve inversions prior to 1969, the emphasis will be on the episodes since the 1969-70 recession.

On average, since 1969, the unemployment rate trough occurred nine months before the NBER-determined recession trough, while the yield curve inversion occurred 10 months before. For both series, the maximum lead time is 16 months before the recession-but in different episodes. The minimum lead times were one month for the unemployment trough and five months for the yield curve inversion. The table also indicates that, on average, the unemployment rate increases by 0.4 percentage points over the eight-month period between the trough and the NBER-defined peak. ⁴

Based on this evidence, it appears that both indicators tend to be reliable predictors of a business recession. Although the signal from the trough of the unemployment rate occurs on average one month before the yield curve inversion, an economic analyst is nonetheless never sure that a trough has occurred. Indeed, the unemployment rate can move up and down over the expansion. For example, from October 1962 to February 1963, the unemployment rate rose from 5.36 percent to 5.95 percent, only to resume falling afterward. By contrast, the yield curve has the advantage that the economic analyst or policymaker does not have to wonder whether an inversion has occurred. But false positives have also occurred with the yield curve, such as the one that occurred in 1966.

Overall, both indicators tend to be reliable signals of a coming recession. But as with all recession signals, the wise economic analysts should examine many indicators rather than betting the farm on one or two.

Notes

Reference

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Recession Signals: The Yield Curve vs. Unemployment Rate Troughs

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In early May 2018, The Wall Street Journal asked professional forecasters to predict when the next recession would begin. Nearly 6 in 10 answered that the next recession will begin sometime in 2020. If so, the current business expansion will have eclipsed the 1991-2001 expansion as the longest on record.

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1. Why is equilibrium at the natural rate of unemployment?

2. Can you accurately draw the ASAD model in a recessionary gap and explain what is happening to unemployment?

3. Can you accurately draw the ASAD model in an inflationary gap and explain what is happening to inflation?

4. Can you describe what happens with demand-pull inflation and cost-push inflation?

5. Can you explain what will happen to the economy in disequilibrium in the long run, even without government involvement?

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fall or left shift in Aggregate Supply is the cause of Cost-Push Inflation. This can occur from an increase in the cost of production or decrease in the volume of production. While Demand-Pull inflation is caused by an increase in the Aggregate Demand curve. An interaction of cost-push inflation and demand-pull inflation results in the Wage Price Spiral.

The wage-price spiral suggests that rising wages increase disposable income, thus raising the demand for goods and causing prices to rise. Rising prices cause demand for higher wages, which leads to higher production costs and further upward pressure on prices.

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Cost-Push Inflation | Intelligent Economist

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fall or left shift in Aggregate Supply is the cause of Cost-Push Inflation. This can occur from an increase in the cost of production or decrease in the volume of production. While Demand-Pull inflation is caused by an increase in the Aggregate Demand curve.

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APMac Unit 3 Lesson 3 - ASAD Short Run & Long Run Flashcards | Quizlet

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Start studying APMac Unit 3 Lesson 3 - ASAD Short Run & Long Run. Learn vocabulary, terms, and more with flashcards, games, and other study tools.