The trade-off between an increase in both national income and price levels depends on how large the output gap is.

Question

Quizplus · Accepted Answer

The size of the output gap determines the extent of the trade-off between national income and price levels. If the economy is operating at full capacity, an increase in national income will lead to an increase in price levels, resulting in inflation. However, if the economy is operating below full capacity with a large output gap, an increase in national income can be achieved without a significant increase in price levels, as there is still room for production to increase before causing inflationary pressures.

The Trade-Off Between an Increase in Both National Income and Price