In an AD/AS model, the point where the economy has excess capacity is called the:

• A. Below full-employment equilibrium
• B. Inflationary gap
• C. Long-run equilibrium
• D. Natural rate of output

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of full employment in the AD/AS model. Full employment occurs when all available resources in the economy are being used efficiently, and the economy is producing at its natural rate of output.
2. Step 2: Recognize that 'excess capacity' means the economy is producing less than its potential output, implying that some resources (like labor and capital) are underutilized.
3. Step 3: Identify that when the economy is operating below full employment, it is producing less than the natural rate of output, which means there is a negative output gap.
4. Step 4: Recall the definitions of the options: 'Inflationary gap' occurs when output exceeds full employment, 'Long-run equilibrium' is when output equals natural rate, and 'Natural rate of output' is the potential output level.
5. Step 5: Conclude that the point where the economy has excess capacity corresponds to the 'Below full-employment equilibrium' because the economy is producing below its potential, with unused resources.