Question

Describe the current state of the economy relative to potential GDP. You are encouraged to use the most recent data from the first quarter 2020 which is available on FRED

Answer 1

Potential GDP for an economy is said to exist when aggregate demand for all the goods and services in an economy is equal to the aggregate supply in the economy, and also that the economy runs at full employment level at potential GDP.

Before Covid-19, the US economy was running at potential GDP with one of the lowest unemployment level in decades, and annual GDP growth averaging around 2%-3%.

However, Covid-19 virus and measures taken to contain the spread of the virus has significantly impacted aggregate demand and supply in the economy. Closure of most of the businesses and industries has led to millions of job losses leading to steep fall in aggregate demand and aggregate supply which in tun has led to the first quarter GDP growth in the country declining by 5 percent, which shows that the current state of the economy has contracted from the potential GDP.