2.5 - Output gaps

Question 1

Actual Growth Rate

Answer 1

• The actual growth rate is the annual percentage increase in real GDP.
• It reflects the economy’s short-term performance, influenced by demand and supply shocks, fiscal and monetary policies, and other cyclical factors.

Question 2

Long-Term Trend Growth Rate

Answer 2

• The long-term trend growth rate is the average rate at which an economy can grow over a sustained period without generating inflationary pressures.
• It is determined by fundamental factors such as technology, labour force growth, capital accumulation, and productivity improvements.

Question 3

Distinction between actual growth rates and long-term
trends in growth rates
(short term vs long term and volatility)

Answer 3

• Short-Term vs. Long-Term:
  > Actual growth rates fluctuate more due to short-term factors, while trend growth rates indicate long-term
  sustainable growth.
• Volatility:
  > Actual growth rates can be highly volatile, whereas trend growth rates are relatively stable.

Question 4

Positive Output Gap

Answer 4

Occurs when actual GDP exceeds potential GDP.
> Indicates that the economy is producing above its sustainable capacity, often leading to inflationary pressures.

Question 5

Negative Output Gap

Answer 5

• Occurs when actual GDP is below potential GDP.
  > Indicates under-utilisation of resources, high unemployment, and deflationary pressures.

Question 6

Difficulties of Measurement for positive and negative output gaps

Answer 6

• Estimation of Potential GDP:
  > Potential GDP is not directly observable and must be estimated, leading to potential inaccuracies.
• Data Revisions:
  > Economic data is often revised, which can change the assessment of output gaps.
• Structural Changes:
  > Changes in the economy’s structure, such as technological advances or demographic shifts, can affect potential GDP estimates.

Question 7

Use of an AD/AS Diagram to Illustrate an Output Gap

Answer 7

AD/AS Diagram:

• The Aggregate Demand (AD) curve represents the total quantity of goods and services demanded at different price levels.
• The Aggregate Supply (AS) curve represents the total quantity of goods and services that producers are willing and able to supply at different price levels.
• Potential Output (Y*): The level of output the economy can produce at full employment (long-term trend).

Question 8

Illustrating positive output gap on an AS AD diagram

Answer 8

• Occurs when the AD curve intersects the AS curve to the right of potential output (Y*).
• Example: AD intersects AS at a point where actual output (Y) > Y*.
• Diagram: Draw AD and AS curves with the intersection to the right of Y*, indicating actual output above potential.

Question 9

Illustrating a negative output gaps

Answer 9

• Occurs when the AD curve intersects the AS curve to the left of the potential output (Y*).
• Example: AD intersects AS at a point where actual output (Y) < Y*.
• Diagram: Draw AD and AS curves with the intersection to the left of Y*, indicating actual output below potential.

Question 10

Real-World Example of negative output gap

Answer 10

During the 2008 financial crisis, the negative output gap was evident as many economies operated below their potential output due to reduced consumer and business spending.

Question 11

Real world example of positive output gap

Answer 11

In the late 1990s, the U.S. economy experienced a positive output gap as high demand and technological optimism drove growth beyond sustainable levels.

Question 12

Output gap

Answer 12

• An output gap is the difference between the actual level of GDP and the estimated long-term value for GDP- this is shown on the trade cycle diagram which demonstrates how the actual GDP is not always on the trend.