recessions and deflation - In SR bcs of wage price...

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In SR bcs of wage & price stickiness, economy may remain above or below its potential level of output Recessionary gap – The gap between the level of real GDP and potential output, when real GDP is less than potential If employment is below natural level, then output is below potential Recessionary Gap Inflationary Gap Inflationary gap – The gap between the level of real GDP and potential output, when real GDP is greater than potential Long-run adjustment to an inflationary gap: An increase  in aggregate demand to AD 2  boosts real GDP to Y 2  and  the price level to P 2 , creating an inflationary gap of Y   Y P . In the long run, as price and nominal wages  increase, the short-run aggregate supply curve moves  to  SRAS 2 . Real GDP returns to potential. A decrease in aggregate supply from SRAS 1  to SRAS reduces real GDP to Y 2  and raises the price level to P 2 creating a recessionary gap of Y P  
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