I. Define the difference between actual and potential real GDP II. What are the
ID: 1144962 • Letter: I
Question
I. Define the difference between actual and potential real GDP II. What are the two ways to represent the long-run growth on III. Suppose economy that produces consumption goods and and their determinants the graphs? Draw both. investment goods operates in point A on the production possibilities frontier. a) How can you characterize this situation? b) Show the situation on the appropriate graph with consumption goods (C) on the horizontal axis and investment goods (I) on the vertical axis. Explain the shape of the curve.Explanation / Answer
1.
Actual Real GDP refer to the final value of the output for the country at the base year prices, whereas the potential Real GDP is the final value of output at base year prices when economy operates at full employment. If actual real GDP is less than the potential GDP, then GDP can further expand and grow to reach the potential real GDP level. In a scenario of actual real GDP less than the potential real GDP, there is a recessionary gap. If actual real GDP is more than the potential real GDP, then there is inflationary gap in the economy. At full employment or potential GDP level, the economy has frictional and structural unemployment only, but below the potential or actual real GDP case, there is cyclical unemployment also other than the frictional and structural unemployment.
There are following determinants of the real GDP:
A. Output and productivity
A superior productivity and higher overall output will increase the real GDP and vice versa. It will also help to increase the per capita real GDP. It will bring the productive and allocative efficiency in the economy, driving the real GDP.
B. Technological advancements
Technological advancements will cause the outward movement in production possibility curve and output level will increase with efficiency utilization of resources. So, real GDP will expand.
C. Government spending and tax cuts
Government spending and tax cuts act as a multiplier effect to stimulate the demand. An increase in demand is catered by the increased supply in the economy. As a result, real GDP will increase. A reverse action takes place when contractionary fiscal policy is applied.
D. Monetary policy initiatives
A monetary policy that brings down the interest rates and promotes the revenue as well as the capital expenditure, will create capabilities and firms can supply to meet the demand. It will also support iexpansion of GDP by increase in output.
E. FDIs in the country
FDIs bring capital investment and make production activities. It increases the real GDP.
F. Formation of capital goods
Increased level of capital goods creation promotes production activities and makes positive impact upon the output or real GDP.
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