What causes GDP to not equal to potential GDP when Investments are NOT equal to savings?
When I<S that means that businesses don't produce as much as people need, which leads people to save more than they would have, which puts the economy in recessionary gap.
When I>S that means that businesses produce more than people need and puts economy in inflationary gap.
These are my explanations. I can tell it's not correct. Can you help me out? Our professors wants us to explain everything with real life events.
- ?Lv 66 months ago
If I is not equal to S, the economy is not in equilibrium. In Keynesian model, AD will not cut the 45 degree line. Even when I=S, and AD cut the 45 degree line, the equilibrium might still under the potential GDP. It is called a deflationary gap. This is because the government purchasing is too low.