- [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.