- [Instructor] What we have here
are two different visualizations of a country's output
at different points in time.
You might recognize here on the left
we have our production possibilities curve for this country.
And it's a very simple country
that either produces forks and/or spoons.
So if it could produce all forks efficiently
it would be right here, that many forks.
If it could produce all spoons efficiently
it would be right here.
And all the combinations of forks and spoons
that it would produce efficiently at its potential,
well that's what defines
this production possibilities curve.
On the right here we have this country's
real GDP versus time.
And so you could view their real GDP as some way
of computing their aggregate production of spoons and forks.
Now we know that real economies
do a lot more than just produce two goods.
They produce millions of goods and services,
but then you would need a graph
that would have millions of dimensions
which is very hard for most of our brains to understand.
But what we have here is,
thinking about three different scenarios
at three different times for this country.
Now we're gonna connect the dots between the visualization
on the left, the production possibilities curve,
and the visualization on the right.
And we're also gonna think about other economic indicators
other than real GDP and how those might play out.
So let's start off at time T sub one right over here.
From what we know of production possibility curves,
what is going on in the economy?
Pause this video and try to think about that.
Well we know that if you're
on your production possibilities curve,
you're operating at your potential.
But here we have a situation
where we are operating beyond our potential.
This is not a sustainable situation.
This is a situation where
some people would argue the economy is overheating.
This is like if on your personal life
if you're pulling all nighters in order to study for a test,
that is not a sustainable situation.
But at T sub one when you're operating above your potential,
it is associated with low unemployment
and many would argue unsustainably low unemployment.
And because there's so much demand for labor,
There's so much demand for utilization
of other resources that that could increase price pressure.
So it's also associated with higher inflation.
Now what would time T sub one,
what could that be on this graph here?
Well I already depicted it.
It could be this point right over here,
where our real GDP is above this horizontal red line
which you could view as our potential GDP,
our full employment GDP, our full employment output.
And so this shows that we have a positive output gap
just as when we're above or beyond our PPC
that is also a positive output gap.
Now sometimes we associate this positive output gap
being performing beyond the potential
as being associated with an expansion versus a recession.
And it is indeed the case that this T sub one
is happening during an expansion.
An expansion is a situation where the GDP is growing.
So this is an expansion here.
And then if we go from the next trough to the next peak,
this is an expansion here.
And the opposite of an expansion is a recession,
so this is a recession where we're going
from a peak to a trough.
And if we go from the next peak to the next trough
that also would be a recession.
So this positive output gap
is happening during an expansion.
But you could have a situation where you're right here
where you have a positive output gap,
where you're operating beyond your potential,
but the economy has started to shrink.
So it's not always the case.
Even though positive output gaps get associated
with expansions, it's not always during an expansion.
But anyway, let's move forward in time.
Let's say for various reasons our economy slows down a bit
and we go to time T sub two.
Now we are actually operating at potential.
We are at our productions possibility curve.
And so at what point could that be on this graph?
Well we have it depicted right here at time T sub two.
The country is operating exactly at its potential.
The country is operating efficiently in a sustainable way.
And then we go to time T sub three.
So at time T sub three it's clear
that we have a negative output gap
and you can see it over here as well.
We have a negative output gap.
And if you think about the economic indicators
other than real GDP what will they be doing?
This is a situation where an economy
is operating below full employment
where the unemployment rate could be elevated,
or it's typically elevated
when you have this negative output gap.
And because both the labor and oftentimes other resources
aren't being fully utilized,
there might not be a lot of price pressure.
So in this situation inflation would be lower.
And in extreme cases you could even have negative inflation,
which we would call deflation.
Now associated with all of these ideas
is the idea of economic growth.
So in everyday language when people talk
about economic growth,
they're usually talking about expansions.
They're talking about situations where real GDP is growing.
But economists, when they talk
about economic growth do not mean that.
To an economist, economic growth
is when the potential of an economy increases.
And we know that the only way that the potential
of an economy increases is if they all of a sudden
have more factors of production, better resources,
better technology, the population has increased.
So economic growth would be associated
with pushing out the actual PPC.
So this would, if you saw now they had more technology
or more people now,
so now that would push out the PBC.
And economic growth, for example, if this red line,
which is the country's potential,
were to increase like this, that would be economic growth.
The actual real GDP at any given time
would likely cycle around that.