If we observe an economy adjusting to potential GDP as prices fall and real output increases,we can conclude that _____.
A)the economy was experiencing an expansionary gap
B)there is a labor surplus
C)the economy was experiencing a recessionary gap
D)self-correction is not the process that is occurring
E)there are widespread labor shortages

Question

Quizplus · Accepted Answer

The economy is adjusting towards potential GDP, which suggests that it was previously operating below potential (i.e. in a recessionary gap). As prices fall and real output increases, this indicates that there is slack in the economy (i.e. a labor surplus) and that self-correction is occurring. A widespread labor shortage would result in an increase in wages and prices, which is not consistent with the scenario described. Therefore, the correct answer is (C) the economy was experiencing a recessionary gap.

If We Observe an Economy Adjusting to Potential GDP as Prices