A report from the Congressional Budget Office (CBO) noted, “Real potential GDP is the maximum sustainable output of the economy adjusted to remove the effects of inflation.” In early 2017, the CBO estimated that the gap between real GDP and potential GDP would fall from 1.1 percent in 2016 to 0.3 in 2018. In 2016, real GDP was $16.7 trillion, and the CBO’s estimate of potential GDP was $16.9 trillion. The CBO forecast that potential GDP would increase to $17.4 trillion in 2018.
a. Why does the CBO include the word sustainable in its definition of potential GDP?
b. Draw an aggregate demand and aggregate supply graph to illustrate the macroeconomic situation in 2016 and in 2018. (You do not have to show on your graph the situation in 2017.) Be sure that your graph contains LRAS curves for 2016 and 2018, SRAS curves for 2016 and 2018, and AD curves for 2016 and 2018, and that it shows equilibrium real GDP and the price levels for both years.