Question

1. (25 points) Suppose that a county is producing at the output level Y₁, illustrated by the figure

below. What type of output gap is the country in?
Price level
Potential output
SRAS
Y₁ Y₂
AD
Real GDP

Answer 1

Negative Output Gap

Step-by-step explanation:

The economy operates in a negative output gap. This is because output is below its potential. In this situation, price level is higher than it should have been if the economy was operating at its full employment equilibrium (Y2). The country in this case can improve productivity which increases aggregate supply thereby pushing output to its potential level and reducing aggregate price level.