Suppose we observe an economy adjusting to potential GDP as prices fall and real output increases.Which of the following describes what the economy is experiencing?
A) It is experiencing an expansionary gap.
B) It is experiencing a shift of the AD curve.
C) It is experiencing a recessionary gap.
D) It is NOT experiencing a self-correction.

Question

Suppose we observe an economy adjusting to potential GDP as prices fall and real output increases.Which of the following describes what the economy is experiencing?  
A) It is experiencing an expansionary gap. 
B) It is experiencing a shift of the AD curve. 
C) It is experiencing a recessionary gap. 
D) It is NOT experiencing a self-correction.

Quizplus · Accepted Answer

When an economy adjusts to potential GDP as prices fall and real output increases, it is experiencing a recessionary gap. This is because the economy's output is increasing and moving closer to potential GDP, but prices are falling, indicating that there is still some slack in the economy. A recessionary gap occurs when the actual level of output is less than the potential or full-employment level, so this situation indicates that the economy is moving towards closing that gap. There is no mention of an expansionary gap or a shift of the AD curve, and the fact that the economy is self-correcting (i.e. moving towards potential GDP on its own) is not in question, so D is not a valid answer.

Suppose We Observe an Economy Adjusting to Potential GDP as Prices