2.5.2 Output gaps

Question 1

Actual growth rate

Answer 1

The percentage increase in a country’s real GDP and usually measured annually. It is caused by increases in AD.

Question 2

Long-term trends in growth rate

Answer 2

The long run expansion of the productive potential of an economy. It is caused by increases in AS.
- The potential output of an economy is what the economy could produce if resources were fully employed.

Question 3

Output gaps

Answer 3

An output gap occurs when there is a difference between the actual level of output and the potential level of output. It is measured as a percentage of national output.

Question 4

Negative output gap

Answer 4

A negative output gap occurs when the actual level of output is less than the potential level of output.
This puts downward pressure on inflation. It usually means there is the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy.

Question 5

Positive output gap

Answer 5

A positive output gap occurs when the actual level of output is greater than the potential level of output.
It could be due to resources being used beyond the normal capacity, such as if labour works overtime. If productivity is growing, the output gap becomes positive. It puts upwards pressure on inflation.
- Example: Countries, such as China and India, which have high rates of inflation due to fast and increasing demand, are associated with positive output gaps.

Question 6

Difficulties with measuring output gap

Answer 6

• It is difficult to estimate the trend in a series of data.
• The structure of the economy often changes, which means estimates may not always be accurate. For example, immediately after a recession, the level of spare capacity might fall below the level anticipated, since some workers might become economically inactive, firms might close and some banks might be unwilling to lend.
• Changes in the exchange rate might offset some inflationary effects of a positive output gap.
• Data is not always reliable, especially from emerging markets, and extrapolating data from past trends might lead to uncertainties.