Question

What is a recessionary GDP gap and why might one arise? What is a potential solution to eliminate this gap? Finally, explain a real economic impact that resulted from the housing bubble.

Answer 1

When actual output falls short of its long run level or potential level, there exists a gap between the two values. This is negative and is called negative output gap or gap due to a recession (recessionary gap). It can mainly arise when the aggregate demand or aggregate supply curves in the goods market, shift to the left in the short run.

A potential solution that works in most cases is a fiscal expansion. This increases income and employment, which gears up / stimulates the stagnant or poised economy

There were many real economic impacts from the housing bubble. Investment in housing was reduced to a large extent and banks were reluctant to advance loans. This increased unemployment in the short run. Hence many real variables faced a dramatic and unexpected change.