2.5.2 Output Gaps

Question 1

define an output gap

Answer 1

the difference between the actual level of real GDP and its estimated potential level

Question 2

what is potential output

Answer 2

potential output represents the level of production an economy can achieve when all resources are fully employed without causing inflationary pressures

Question 3

what is a negative output gap

Answer 3

a situation where an economy’s actual output or real GDP is below its potential output

Question 4

how is a negative output gap illustrated on a diagram

Answer 4

• show an AD and SRAS equilibrium
• draw classical LRAS curve to right of equilibrium and label long run equilibrium

Question 5

what are the features of a negative output gap

Answer 5

• often corresponds with a recession/slump
• can lead to higher unemployment and under-utilised resources
• might also lead to disinflationary effects

Question 6

what is a positive output gap

Answer 6

a situation where an economy’s actual output or real GDP is above its potential output

Question 7

how is a positive output gap illustrated on a diagram

Answer 7

• show an AD and SRAS equilibrium
• shift AD to the right to create new short run equilibrium beyond the LRAS curve

Question 8

explain how a positive output gap comes about

Answer 8

something e.g a credit boom drives up consumer spending and leads to a surge in aggregate demand so producers will expand production by making existing factors of production work harder (labour)

Question 9

what are the features of a positive output gap

Answer 9

• often corresponds to a boom
• can lead to lower unemployment and better-utilised resources
• might also lead to inflationary effects

Question 10

what is the classical view on positive output gaps

Answer 10

• a positive output gap cannot be sustained in the long run, as factor resources are scarce
• wages get bid up and costs of production rise
• SRAS will then shift inwards, restoring equilibrium and closing the output gap

Question 11

how do you illustrate the classical view of a positive output gap on a diagram

Answer 11

• draw positive output gap as usual
• shift SRAS inwards to meet LRAS and AD2 equilibrium (full capacity)

Question 12

what leads to an increase in national income without an increase in the rate of inflation, generally

Answer 12

anything that improves quality or quantity of factors of production