Answer to Question #224266 in Macroeconomics for oreo

Question

potential GDP relationship between price level and inflation rate?

Answer 1

Changes in price levels with money wage rate and prices of other resources remaining constant, shifts the real GDP to potential GDP and this results in a movement along the Aggregate supply curve.

Price levels are the leading indicators in the economy, rising prices indicate higher demand that leads to inflation whereas a fall in prices indicates lower demand and hence, deflation.

When GDP is higher than potential, the economy is operating above its sustainable capacity and is most likely to generate inflation. In this case, the output gap is positive.

When real GDP is less than potential GDP, the economy is operating below its sustainable capacity and there will be deflation. In this case the output gap is negative.