a) Starting with a supply side growth rate of 3%, assume that due to the severit

Question

a) Starting with a supply side growth rate of 3%, assume that due to the severity of the recession, annual supply side growth rate decreases to 2% beginning in 2009q1. Potential GDP will be the same as with the 3% calculation through 2008q4 and then grow at a slower 2% rate after that. Calculate the value of potential GDP that could have been realized in 2015q3 using the 2% supply side growth rate starting in 2009q1. Remember that 3% and 2% are annual growth numbers and we are dealing with quarterly observations when you make the calculation for 2015.

b) What is the amount of the output gap?

Explanation / Answer

(a) Potential GDP in 2009q1 = $14,375 billion

Growth rate = 2% or 0.02

Calculate Potential GDP in 2010q1 -

Potential GDP = Potential GDP in 2009q1 * (1+r)n = $14,375 billion * (1+0.02)1 = $14,662.5 billion

Calculate Potential GDP in 2011q1 -

Potential GDP = Potential GDP in 2010q1 * (1+r)n = $14,662.5 billion * (1+0.02)1 = $14,955.7 billion

Calculate Potential GDP in 2012q1 -

Potential GDP = Potential GDP in 2011q1 * (1+r)n = $14,955.7 billion * (1+0.02)1 = $15,254.8 billion

Calculate Potential GDP in 2013q1 -

Potential GDP = Potential GDP in 2012q1 * (1+r)n = $15,254.8 billion * (1+0.02)1 = $15,559.9 billion

Calculate Potential GDP in 2014q1 -

Potential GDP = Potential GDP in 2013q1 * (1+r)n = $15,559.9 billion * (1+0.02)1 = $15,871.1 billion

Calculate Potential GDP in 2015q1 -

Potential GDP = Potential GDP in 2014q1 * (1+r)n = $15,871.1 billion * (1+0.02)1 = $16,188.5 billion

Calculate Potential GDP in 2015q2 -

AS we have to now calculate the GDP for one quarter only, rate of growth will be divided by 4 and time period will be multiplied by 4.

There are 4 quarters in the year.

Potential GDP = Potential GDP in 2015q1 * (1+r)n = $16,188.5 billion * (1+0.005)4 = $16,512.3 billion

Calculate Potential GDP in 2015q3 -

Potential GDP = Potential GDP in 2015q2 * (1+r)n = $16,512.3 billion * (1+0.005)4 = $16,842.5 billion

The value of potential GDP in 2015q3 is $16,842.5 billion.

(b) Calculate Output gap -

Output gap = Actual real GDP - Potential GDP

                 = $16,414.0 billion - $16,842.5 billion

                 = -$428.5 billion

The amount of output gap is -$428.5 billion.

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