Question

Suppose the economy is currently in short run macroeconomic equilibrium, with actual GDP bigger than potential GDP.

(a) Depict this situation using AD-AS, being sure to label all curves and axes. What is the gap called?
(b) In the long run, what will happen to prices and output? Depict graphically and explain.

Answer 1

attached below

Step-by-step explanation:

Given that the economy has its actual GDP > potential GDP

A) using AD-AS to depict the situation

attached below is the graph

The gap( Lf - L1 ) is called inflationary gap

x-axis = real GDP , Y-axis = price level,

AD = aggregate demand curve , S = short run aggregate supply curve

L = long run aggregate supply curve,

B) In the long run the graph will adjust to the full employment level

attached below is the graph