Friday, October 29, 2010

Another nice graph of Actual RGDP relative to Potential RGDP...Impress your High School (guess that is me) or College Econ teacher with this knowledge

Another nice graphic illustrating the output gap, which is the difference between what we actually produce and the output potential of our economy, as measured  by Real GDP:

In common graphical form that we have come to know so well in AP Macroeconomics, we can illustrate the output gap in both the Production Possibilities Frontier and the Aggregate Demand/Aggregate Supply Model of the Economy:

The PPF shows our productive capacity in terms of raw production of capital and consumer goods.  The Long Run Aggregate Supply Curve (LRAS) is this raw production converted to inflation-adjusted GDP.   We know we are not always at our potential in the PPF. Sometimes we are outside it and sometimes we are inside it.  We can certainly say our economy today is under-producing/under-utilizing resources, mainly people (9.6% unemployment rate, well over the Natural Rate of Unemployment). 

Point "B" represents the under-employing of resources relative to our potential Point "A". When we convert the raw production at Point "B" to inflation-adjusted prices, we get a Real GDP to the left of our FE RGP. This is represented as movement along our Short-Run Aggregate Supply curve to Point "B" on the  AD/AS Model. 

How soon do we close the gap between Actual RGDP and Potential RGDP? The first graph gives two Real GDP growth rate examples. One is the growth rate from the end of last severe recession we experienced, 1983-84. The second is a tepid growth that seems to be the consensus growth rate we will actually have (again, this is a best guesstimate scenario). Recovery back to full-employment is not going to be quick, UNLESS we get a HUGE positive Aggregate Supply Shock, such as the one in the 1990's.  Don't see that is going to happen, but as mentioned in class, I WISH it would come in the alternative energy sector--significantly reduce energy costs in a clean way,  which will significantly reduce the cost of production across the board. In turn, this may open up new possibilities in a broad range of industries.  Any other suggestions as to what you would like see contribute to a "Positive Supply Shock"??? Let me know--I am always willing to learn new things!
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