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Full Employment GDP

Avery Gordon, DOUGLAS HAWKS
  • Author
    Avery Gordon

    Avery Gordon has experience working in the education space both in and outside of the classroom. He has served as a social studies teacher and has created content for Ohio's Historical Society. He has a bachelor's degree in history from The Ohio State University.

  • Instructor
    DOUGLAS HAWKS

    Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Learn the full employment definition and understand how full employment output is represented in economics. Study different perspectives of full employment GDP. Updated: 12/14/2021

What is Full Employment GDP?

What is Full Employment GDP? Full Employment GDP is an economic term that is used to describe a healthy economy producing at its potential. The term itself can be a bit of a misnomer because the entire country does not have to be employed for the economy to reach a state of full employment GDP. There will always be a certain level of unemployment in any given economy due to factors such as people making career changes, recent college graduates looking for their first career, or new technology that makes some jobs obsolete. What full employment represents is an economy's output when operating at the lowest sustainable rate of unemployment. This is achieved when there is an equilibrium between aggregate demand and short and long-term aggregate supply.

Aggregate demand represents the total amount of money being spent by consumers, investment, the government, and foreign countries at a given price level. Essentially, it's what people in an economy are willing to spend at the current price of goods and services. Aggregate supply represents the total output by firms at a given price level. In other words, the aggregate supply is the amount of goods and services companies are willing to supply at the current price level. Unlike aggregate demand, aggregate supply is measured both in the short term and the long term. This is due to the fact that short-term wages are sticky, which matters for supply because it affects cost production. In the long term, wages are flexible and adjust. When an economy is at full employment output, aggregate demand (AD), short-term aggregate supply (SRAS), and long-term aggregate supply (LRAS) all align, meaning the amount of goods and services being demanded at the current price level matches the amount of goods and services being produced at that same price level.

Full Employment GDP Graph

The concept of aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) aligning to create full employment output can be represented in a graph. See the following full employment graph:

An economy at full employment GDP

what is full employment - Full Employment

In this graph, the AD curve, the SRAS curve, and the LRAS vertical line all meet up. The point on the graph where they meet represents full-employment GDP.

What Is Full Employment GDP?

Full employment GDP is a term used to describe an economy that is operating at an ideal level of employment, where economic output is at its highest potential. It is a state of balance in which savings is equal to investment and the economy is neither expanding too rapidly nor falling into a recession. This level of economic output, as measured by real GDP, is neither too high to cause rising inflation nor too low to bring about falling prices.

In economics, equilibrium is that perfect state of balance, like two friends on a teeter-totter that weigh exactly the same. Absent any external force or change in weight, two friends that weigh the same will sit on a teeter-totter and it will rest completely horizontal. But, as soon as the weight of one side changes, the other side reacts. The two economic forces that must be in equilibrium to achieve full employment GDP are unemployment and inflation.

When unemployment goes down, inflation tends to go up, and when unemployment goes up, inflation tends to fall. All economies have a state of balance like this that we call the full employment level of gross domestic product, or full employment GDP for short.

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Full Employment Output and Economic Growth

Classically, full employment output is also called potential output. This makes sense given that when an economy is in full employment output it is matching its potential. Economic growth is a long-term increase in a country's ability to produce goods and services. When this happens, LRAS moves to the right on the graph from the previous section. This causes a country's full employment GDP or potential output to increase. Aggregate demand and short-run aggregate supply will adjust to the growth.

It's important to understand the difference between economic growth, which is a long-term change, and a temporary increase or decrease in GDP because of a shift in AD or LRAS. When a short-term change happens, this will cause the economy to be out of sync and no longer at its potential output. When a shift occurs that causes the economy to produce under its potential output, it is experiencing a recessionary gap. If the economy produces over its potential output, then the economy is in an inflationary gap. The difference between the two can be seen in the following graphs

An economy experiencing a recessionary gap

what is full employment - An economy experiencing a recessionary gap

An economy experiencing an inflationary gap

what is full employment - An economy experiencing an inflationary gap

Full Employment: Examples of Perspectives

It is important to consider how full employment affects the economy through multiple perspectives such as the labor market, inflation, and savings. These different perspectives are affected depending on if the economy is at full employment, in a recessionary gap, or in an inflationary gap.

Illustrating Full Employment GDP

Here is how economists illustrate full employment GDP. The red upward-sloping curve is called the short-run aggregate supply curve, or SRAS for short. This curve represents the economy's total supply of goods and services. The blue downward-sloping curve is the aggregate demand curve, or AD for short. This curve represents the economy's total demand for goods and services. Finally, the black vertical line is called the long-run aggregate supply curve, or LRAS for short. It represents the economy's long-run potential output of goods and services.

GDP Full Employ

When all three of these lines intersect, there is both a short-term and a long-term equilibrium. In other words, the teeter-totter is horizontal - everything is in perfect balance and everyone lives happily ever after.

Full Employment GDP and Economic Growth

However, life is not always like that. The ups and downs of the economy - the expansions and contractions - in real GDP that we continue to experience over time will bring it above or below full employment.

For example, during a recession, additional unemployment is generated, which we call cyclical unemployment, or unemployment that is directly caused by an economic slowdown. As firms and employees adjust their expectations to the ups and the downs, cyclical unemployment dissipates and the economy generally moves back towards its potential output, or full employment.

In the long run, economic output, as measured by GDP, returns to the full employment level, which classical economists refer to as potential output. Potential output is the highest level of real GDP that an economy can sustain over time.

Full Employment and the Labor Market

So far, we've looked at full employment from the economy-wide level. Now let's take a look at it from the perspective of the labor market. Full employment GDP occurs when the labor market is in equilibrium. This means that there is no surplus of workers above the economy's natural rate of unemployment nor any shortage of workers below it.

Economists would say it this way: All available labor is being used efficiently. The largest amount of people who could be employed are employed. The only unemployment that occurs during this time is when workers are in between jobs - something economists call frictional unemployment and something that is always expected to happen.

Why is this important? Because the natural rate of unemployment is not zero. You would think the economy's potential would be zero unemployment, but as long as some people are in between jobs, it will never be zero. The natural rate of unemployment is estimated to be somewhere between 2% and 4%. This represents a state of equilibrium within the labor market.

Full Employment and Inflation

When the economy is at the full employment level, this level of economic output as measured by real GDP and the level of employment is neither too high to cause rising inflation nor too low to bring about falling prices. Yale economist James Tobin called this the non-accelerating inflation rate of unemployment.

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Video Transcript

What Is Full Employment GDP?

Full employment GDP is a term used to describe an economy that is operating at an ideal level of employment, where economic output is at its highest potential. It is a state of balance in which savings is equal to investment and the economy is neither expanding too rapidly nor falling into a recession. This level of economic output, as measured by real GDP, is neither too high to cause rising inflation nor too low to bring about falling prices.

In economics, equilibrium is that perfect state of balance, like two friends on a teeter-totter that weigh exactly the same. Absent any external force or change in weight, two friends that weigh the same will sit on a teeter-totter and it will rest completely horizontal. But, as soon as the weight of one side changes, the other side reacts. The two economic forces that must be in equilibrium to achieve full employment GDP are unemployment and inflation.

When unemployment goes down, inflation tends to go up, and when unemployment goes up, inflation tends to fall. All economies have a state of balance like this that we call the full employment level of gross domestic product, or full employment GDP for short.

Illustrating Full Employment GDP

Here is how economists illustrate full employment GDP. The red upward-sloping curve is called the short-run aggregate supply curve, or SRAS for short. This curve represents the economy's total supply of goods and services. The blue downward-sloping curve is the aggregate demand curve, or AD for short. This curve represents the economy's total demand for goods and services. Finally, the black vertical line is called the long-run aggregate supply curve, or LRAS for short. It represents the economy's long-run potential output of goods and services.

GDP Full Employ

When all three of these lines intersect, there is both a short-term and a long-term equilibrium. In other words, the teeter-totter is horizontal - everything is in perfect balance and everyone lives happily ever after.

Full Employment GDP and Economic Growth

However, life is not always like that. The ups and downs of the economy - the expansions and contractions - in real GDP that we continue to experience over time will bring it above or below full employment.

For example, during a recession, additional unemployment is generated, which we call cyclical unemployment, or unemployment that is directly caused by an economic slowdown. As firms and employees adjust their expectations to the ups and the downs, cyclical unemployment dissipates and the economy generally moves back towards its potential output, or full employment.

In the long run, economic output, as measured by GDP, returns to the full employment level, which classical economists refer to as potential output. Potential output is the highest level of real GDP that an economy can sustain over time.

Full Employment and the Labor Market

So far, we've looked at full employment from the economy-wide level. Now let's take a look at it from the perspective of the labor market. Full employment GDP occurs when the labor market is in equilibrium. This means that there is no surplus of workers above the economy's natural rate of unemployment nor any shortage of workers below it.

Economists would say it this way: All available labor is being used efficiently. The largest amount of people who could be employed are employed. The only unemployment that occurs during this time is when workers are in between jobs - something economists call frictional unemployment and something that is always expected to happen.

Why is this important? Because the natural rate of unemployment is not zero. You would think the economy's potential would be zero unemployment, but as long as some people are in between jobs, it will never be zero. The natural rate of unemployment is estimated to be somewhere between 2% and 4%. This represents a state of equilibrium within the labor market.

Full Employment and Inflation

When the economy is at the full employment level, this level of economic output as measured by real GDP and the level of employment is neither too high to cause rising inflation nor too low to bring about falling prices. Yale economist James Tobin called this the non-accelerating inflation rate of unemployment.

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Frequently Asked Questions

What is full employment in economics?

Full employment represents an economy that is experiencing an equilibrium in aggregate demand and aggregate supply (long and short term). This is also called potential output.

What is considered a full employment rate?

The full employment rate means the economy has the lowest stable level of unemployment. There will always be some unemployment due to people being between jobs.

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