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9.2: Depressions, Recessions and the AS/AD

  • Page ID
    287971
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    The AS/AD framework was introduced in the last lesson. This tool can be used to visualize an economy that is not generating enough economic activity to make use of all resources (especially labor).

    All economies need a certain amount of activity (i.e., output) to provide opportunities for people to earn a living. Let’s give the amount of output needed for the economy to operate at full employment the identity QF. If the economy produces less than QF then the unemployment rate will climb. See figure 3.

    clipboard_eb1db46943657c458e592c5b2304ac262.png

    Figure 3

    During a recession the equilibrium level of output (QE) is less than QF. See figure 4.

    clipboard_e47e6acc06d647bf8a40ebb9e35b10a3d.png

    Figure 4

    If QE is less than QF then difference between the two is referred to as the GDP gap (see figure 4). If QE is greater than QF the difference is called the inflationary gap. The greater the gap between the actual output (QE) and the full-employment level of output (QF) the deeper the recession. From 1929-1933 the economy shrank by about 27%. This was a sudden and dramatic fall that put the actual rate of output well below the full-employment rate. Figure 5 puts the magnitude of the drop in economic activity during the early part of the 1930s into perspective by comparing it to falls in GDP during other U.S. recessions.

    clipboard_e2995b4351677da688a88fe2e86003bed.png

    Figure 5

    The questions on everyone’s mind during the 1930s were:

    • When will the economy recover?
    • Is there anything that can be done to bring on recovery sooner?

    This page titled 9.2: Depressions, Recessions and the AS/AD is shared under a CC BY-NC-SA 4.0 license and was authored, remixed, and/or curated by Martin Medeiros.