Figure 16-3
Panel (a) Panel (b) Suppose the level of potential output (Y P ) is $1,000 billion and the natural rate of unemployment is 5%. In Panel (a), the aggregate demand curve in Period 1 is AD 1 . Assume that the price level in Period 1 has risen by 1.5% from the previous period and the unemployment rate is 10%. Thus, in Panel (b) point F shows an initial rate of inflation of 1.5% and an unemployment rate of 10%. Similarly, point b in Panel (a) corresponds to point G in Panel (b) and point d in Panel (a) corresponds to point H in Panel (b).
-Refer to Figure 16-3. If the economy were experiencing a recessionary gap, it would be
Operating at
A) point a only.
B) point b only.
C) either point a or point b.
D) point d only.

Question

Figure 16-3
Panel (a) Panel (b)   Suppose the level of potential output (Y P ) is $1,000 billion and the natural rate of unemployment is 5%. In Panel (a), the aggregate demand curve in Period 1 is AD 1 . Assume that the price level in Period 1 has risen by 1.5% from the previous period and the unemployment rate is 10%. Thus, in Panel (b) point F shows an initial rate of inflation of 1.5% and an unemployment rate of 10%. Similarly, point b in Panel (a) corresponds to point G in Panel (b) and point d in Panel (a) corresponds to point H in Panel (b).
-Refer to Figure 16-3. If the economy were experiencing a recessionary gap, it would be
Operating at
A) point a only. 
B) point b only. 
C) either point a or point b. 
D) point d only.

Quizplus · Accepted Answer

Panel (a) shows that potential output is higher than actual output at points a and b. Since point a corresponds to an unemployment rate above the natural rate and point b is characterized by an inflation rate that is higher than the initial rate of inflation, it is possible that the economy is experiencing a recessionary gap at either point a or point b. Therefore, the best choice is C, either point a or point b. Point d corresponds to a higher level of output than potential output, indicating an inflationary gap instead of a recessionary gap.