2.5.2 Output gaps

Question 1

Negative output gap
(also called a recessionary gap)

Answer 1

The difference between the level of actual output and trend output when actual output is below trend output.

• A negative output gap will occur during a recession when the economy is under-performing, as some resources will be unused or underused (including labour, so unemployment may be high).
• A negative output gap also usually means downwards pressure on inflation.

Question 2

Positive output gap
(also called a inflationary gap)

Answer 2

The difference between the level of actual output and trend output when actual output is above trend output.

• A positive output gap will occur during a boom when the economy is overheating, as resources are being fully used or overused (so unemployment may be low).
• A positive output gap also usually means upwards pressure on inflation.

Question 3

Trade cycle diagram showing output gaps

Answer 3

Question 4

PPF showing output gaps

Answer 4

• Point W shows the economy operating at full capacity – all available resources are being used.
• Point X is inside the PPF. This shows that some resources are not being fully utilised – there’s a negative output gap.
• Point Z is outside the PPF, meaning the economy is producing a level of output that is ‘beyond its potential’ – this may happen if workers are working excessively long hours or machines are being overused. | In this case there is a positive output gap.