When output is less than potential output:
(i) there is insufficient demand.
(ii) demand-pull inflation occurs.
(iii) the output gap becomes negative.
(iv) the output gap becomes positive.
A)(i) only
B)(ii) and (iv)
C)(i) and (iii)
D)(i), (ii), and (iv)

Question

Quizplus · Accepted Answer

When output is less than potential output, it means that the economy is producing below its capacity. This creates a negative output gap (iii), which means that there is unused capacity in the economy. This could be due to insufficient demand (i) for goods and services in the economy, leading to unused resources. However, if demand were to pull up and exceed the potential output, then the output gap would become positive and inflation would occur (ii). Since (ii) only applies when the output gap is positive, and (i) and (iii) make logical sense, the correct answer is (C) (i) and (iii).

When Output Is Less Than Potential Output