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Figure: Policy Alternatives
-(Figure: Policy Alternatives) Refer to Figure: Policy Alternatives. The economy in panel (b) is initially in short-run equilibrium at real GDP level Y₁ and price level P₂. At real GDP level Y₁ there is:

Question

Use the following to answer questions:
Figure: Policy Alternatives

-(Figure: Policy Alternatives) Refer to Figure: Policy Alternatives. The economy in panel (b) is initially in short-run equilibrium at real GDP level Y₁ and price level P₂. At real GDP level Y₁ there is:

Quizplus · Accepted Answer

The economy is in a recessionary gap at Y₁ because this output level is below the potential output (Yp). The potential output is at the intersection of the LRAS and AD curves. In panel (b), the LRAS curve intersects the AD curve at a level of output above the short-run equilibrium output. Therefore, in the long-run, the economy will move towards the potential output level Yp, which would be the long-run equilibrium. Thus, the correct answer is B, a recessionary gap.

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