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What Is a Recessionary Gap?

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  • Written By: Jim B.
  • Edited By: Jacob Harkins
  • Last Modified Date: 19 December 2014
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A recessionary gap occurs when an economy is operating in the short term at a level below the potential full-employment equilibrium level. This means that the gross domestic product being achieved is lower than it would be at the level of full employment, which causes prices within the economy to drop to achieve balance. The presence of a recessionary gap, also known as a contractionary gap, usually means that a recession is near, often caused by a high exchange rate that reduces income from exports. It's usually accompanied by reduced consumer investments due to poor take-home pay and high unemployment.

Full-employment equilibrium is a measure of how the economy should behave if unencumbered by outside forces. One of two outcomes is possible when the actual level of gross domestic product differs from what it should be if the economy were operating at full employment. If the level is higher than the full-employment equilibrium level, then an inflationary gap is the result. A lower level means that a recessionary gap is occurring.

The main outcome of a recessionary gap is unemployment, a societal ill that makes understanding recessionary gaps so important to economists. Such gaps occur because the prices of resources remain relatively constant, as do workers' wages. Should a downturn in the economy occur, then the demand for resources would drop. This is when unemployment levels rise, since the demand for employment and production drops even as prices and wages stay rigid.

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Gaps in the economy occur as the result of the difference between full-employment equilibrium and the short-run aggregate markets. Whereas the equilibrium is unaffected by outside forces, the aggregate markets represent the push and pull of supply and demand. A recession will cause the amount of gross domestic product to drop below the full-employment level. For example, an economy which is producing only $10 million US Dollars (USD) in gross domestic product but could be producing $15 million USD at full-employment equilibrium would have a recessionary gap of 5 million USD.

When this occurs, steps are often taken by outside forces in an attempt to once again achieve balance in the economy. Most often this is achieved via an increase in government spending or a reduction in taxes. If these methods are effective, then the unemployment level should decrease as demand for more production rises, raising the aggregate markets to the level of full-employment equilibrium. These methods as a whole are known as expansionary fiscal policy, which is the most proven method available for closing the recessionary gap.

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SauteePan
Post 6

@GreenWeaver - I think that the recessionary gap has also affected manufacturers because many have adjusted their packaging in order to remain competitive.

For example, if a box of cereal would normally have twelve ounces, the new package would have ten ounces and cost the same. This way the consumer is paying the same amount, but they are getting far less than they used to.

I also have seen a grocery store that used to sell a full bag of grapes that would retail for about $6 or $7 dollars now only sell these grapes with a half full bag which would be half of the price of the full size. This way the customer is more likely to buy the grapes because it doesn't seem so expensive.

GreenWeaver
Post 5

@SurfNturf- I know what you mean. I think that the restaurant industry has really been hurt by the recessionary gap because dining is something that a lot of people consider a luxury and something that they can live without.

I think that this is why I have been seeing a lot of coupons for restaurants that I didn’t used to see. I think that this is happening more and more with the growth of sites like Groupon.

surfNturf
Post 4

I think that the increased business regulations and taxes also has had a detrimental effect on the economy and caused more of recessionary gap. Some businesses are not only laying off employees but they are taking these jobs overseas in order to cut expenses.

Other companies are improving their technology and automating many tasks that employees used to do in order to enhance the company’s profitability.

The thing is that once these jobs leave the United States I wonder how many will return after the economy improves. Many say that these jobs will be gone for good because companies have learned to function more efficiently.

Perdido
Post 3

@kylee07drg --I have noticed it, and not just in clothing stores. I was able to refurnish my living room because of major markdowns in furniture stores. I got a sofa, a recliner, and a coffee table for what I would have paid just for the sofa in the past!

I would just say to enjoy it while you can. If you have some remodeling to do, do it now while prices are low. If you want a good deal on a nice vacation, take advantage of the recessionary rates. We all want the economy to pick up, but we will miss these deals when they are gone.

kylee07drg
Post 2

I have noticed an increase in major sales during a recessionary gap. It seems that every time I enter a clothing store, merchandise is 25% to 75% off, and I definitely am not complaining.

It used to be hard for me to pay regular prices for stylish clothing. I always felt like I should be using it for something more fundamental. Now, I don’t feel bad at all spending about half of what I used to and getting more for it.

Has anyone else noticed this change in prices all around? I really don’t think that I am imagining it.

Oceana
Post 1

The newspaper where I work was affected by the recessionary gap. We had to offer special deals just to get our regular customers to advertise, and we had to downsize in both positions and hours of remaining employees to make up the gap.

One technique our paper used was offering online subscriptions at a rate of $5 a month to attract new internet-savvy customers. This generated a good bit of interest. We were able to sell some web ads because of it, also.

In spite of the offers, two people lost their jobs, and the salaries of some sales reps were lowered. The paper had to recoup from the major loss in sales.

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