Recessionary gaps, also known as contractionary gaps, refer to a situation in which a country’s real Gross Domestic Product (GDP) falls below its potential output at full employment. To understand why recessionary gaps occur, it is necessary to understand the different levels of economic growth and how they are determined.

At full employment, the quantity of labor supplied by workers is equal to the quantity of labor demanded by employers. This causes wages to reach the level of equilibrium, which is the most efficient wage level for the labor market. However, when there is an economic downturn and business activity slows, less labor is demanded, causing a decrease in wages. In such an instance, the labor market moves from its equilibrium level, resulting in a recessionary gap.

Recessionary gaps occur when the economy is not in full employment. This leads to a decrease in the GDP, resulting in a lower potential output than was previously attainable. In addition, when real wages fall, it becomes more difficult for families to make their budget, leading to an overall decrease in their living standards.

Government policies can be used to close recessionary gaps and increase the real GDP. For instance, fiscal policy can be implemented to increase demand for commodities, stimulating production and increasing wages. Monetary policy can also be used to reduce interest rates and encourage borrowing, leading to an increase in consumption and investment.

In conclusion, a recessionary gap occurs when a country’s real GDP is lower than its full employment. Policymakers have a variety of options available to them when it comes to closing the recessionary gap and increasing real GDP. These include fiscal and monetary policies such as increasing demand for commodities, reducing interest rates and encouraging borrowing.