Because firms maintain preset prices in the short run,output gaps arise in response to changes in

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Output gaps arise in response to changes in economy-wide spending because firms maintain preset prices in the short run. If there is an increase in economy-wide spending, demand for goods and services will increase, leading to an increase in output. However, because firms maintain preset prices, they will not immediately increase their prices to match the increase in demand. As a result, there will be an output gap as firms try to meet the increased demand without increasing prices. Similarly, if there is a decrease in economy-wide spending, demand for goods and services will decrease, leading to a decrease in output, but firms will not immediately decrease their prices, leading to an output gap.

Because Firms Maintain Preset Prices in the Short Run,output Gaps