In the short run, the equilibrium price level will---and the nation will experience---gap because desired investment---and the short-run equilibrium level of real GDP per year is---real GDP at full employment
In the short run, the equilibrium price level may rise or fall depending on the specific circumstances. The nation may experience either an inflationary or a deflationary gap because desired investment may not fully align with consumer spending. The short-run equilibrium level of real GDP per year may be lower than the potential GDP at full employment.
Suppose that the real interest rate suddenly increases
for reasons that have nothing to do with the value of the price level. What happens to the nation's aggregate demand curve? In the short run, will the nation experience an inflationary gap or a recessionary gap? Explain.In the short run, the equilibrium price level will---and the nation will experience---gap because desired investment---and the short-run equilibrium level of real GDP per year is---real GDP at full employment
If the real interest rate suddenly increases for reasons unrelated to the value of the price level, the nation's aggregate demand curve will shift leftward. This is because higher interest rates tend to decrease consumer and business spending, which decreases the demand for goods and services.
In the short run, the nation will likely experience a recessionary gap as the decrease in aggregate demand will cause a decrease in real GDP below the potential GDP at full employment.
The equilibrium price level will decrease in the short run as the decrease in aggregate demand leads to a decrease in prices. The nation will experience a recessionary gap because desired investment will decrease due to the increase in interest rates, and the short-run equilibrium level of real GDP per year will be lower than the potential GDP at full employment. This could potentially lead to higher unemployment as businesses may lay off workers in response to the decrease in demand.
In the short run, the equilibrium price level will be determined by the interaction of aggregate demand and aggregate supply. If aggregate demand exceeds aggregate supply, there will be upward pressure on prices, leading to an increase in the price level. Conversely, if aggregate supply exceeds aggregate demand, there will be downward pressure on prices, leading to a decrease in the price level.
If the nation experiences a gap, it means that the actual level of real GDP is different from the equilibrium level of real GDP. Specifically, there are two types of gaps:
1. Inflationary gap: This occurs when the actual level of real GDP is above the equilibrium level of real GDP. It is typically associated with strong aggregate demand, leading to increased prices and potential inflationary pressures in the economy.
2. Recessionary gap: This occurs when the actual level of real GDP is below the equilibrium level of real GDP. It is typically associated with weak aggregate demand, leading to high unemployment and underutilized resources in the economy.
The desired investment plays a crucial role in determining the equilibrium level of real GDP. Investment is one of the components of aggregate demand and can have a multiplier effect on the overall level of economic activity. If desired investment increases, it will shift the aggregate demand curve to the right, leading to an increase in the equilibrium level of real GDP. Conversely, if desired investment decreases, it will shift the aggregate demand curve to the left, leading to a decrease in the equilibrium level of real GDP.
The specific value of the equilibrium level of real GDP at full employment can vary depending on various factors, such as the level of technology, labor force participation, and capital stock. It represents the level of real GDP where all available resources in the economy are fully utilized, and there is no cyclical unemployment.