2.5.2 - Output gaps

Question 1

What is potential output?

Answer 1

This occurs when the economy is working at full capacity over the long-term.

This occurs when all the factors are working efficiently.

The economy can work above potential output in the short-run but pressure on factors of production such as labor means that it is unsustainable in the long-run.

Question 2

What is an output gap?

Answer 2

This is the difference between actual and potential national output.

Question 3

When does a negative output occur?

Answer 3

A negative output gap happens when the actual rate of economic growth is below the long-run trend rate. This happens during low or negative economic growth and is associated with deflationary pressure and high unemployment. This current account deficit will improve as reduced incomes and higher unemployment means an decrease in demand for imports.

A negative output gap means that an economy has a large margin of spare productive capacity.

Question 4

When does a positive output occur?

Answer 4

A positive output gap happens when the actual rate of economic growth is above the long-run trend rate.

This happens during high economic growth and is associated with inflationary pressure and low unemployment.

This current account deficit will worsen as increased incomes and lower unemployment means an increase in demand for imports.

Question 5

What is unemployment?

Answer 5

The number of people looking for work but who cannot find a job at a point in time.

Question 6

What’s the definition of inflation?

Answer 6

The rate of change in the average price level over time.

Question 7

Why is the output gap difficult for us to measure?

Answer 7

• It requires us to measure aggregate demand
• It also requires us to measure aggregate supply. This is problematic because we need to measure the skills of the labor force and changes in captial assets such as machinery
• Potential output is based on esitmates of the supply of labor, capital stock and productivity of factors of production.
• As there are estimates the information is inaccurate

Question 8

What is productivity?

Answer 8

This is the output per unit of input

Question 9

What are the factors of production?

*remember CELL

Answer 9

Capital, enterprise, labor and land

Question 10

Draw a LRAS + AS curve which shows a postive output gap

Answer 10

Answer is on page 188 of your theme 2 booklet.