Question

How do recessionary and inflationary GDP gaps arise?

Answer 1

Recessionary GDP Gap :-

When in an economy the output exceeds the aggregate demand at the current price levels, the producers cut down the output and the employement, this leads to low income levels and cause a decline in the consumer expenditures, thus leading to widening in the GDP gap, because now demand will decrese further low, and therefore in order to sustain profit margins, firms will again reduce the incomes or cut off employement.

Inflationary GDP Gap:-

Inflation is caused when there is high demand in the market, now in order to fulfill the raising demand producers will increase there output and the employement levels will increase, this rise in employement will increase the income levels, therefore this money will be reflected in increased purchasing parity of the consumers, now this full further aggrevate the demand in the economy thus rising the GDP gap.