5. Output Gaps

Question 1

What is a negative output gap?

Answer 1

Negative output gap: Potential output is greater than actual output.

Question 2

What is a positive output gap?

Answer 2

Positive output gap: Actual output greater than potential output.

Question 3

What are the 3 ways of illustrating Output gaps?

Answer 3

1. PPF/PPC diagram
2. Using the economic cycle diagram
3. AS/AD diagram

Question 4

What is the Trend line?

Answer 4

The trend line represents the potential output.

Question 5

What are the causes of a Negative Output Gap?

Answer 5

1. Structural effect e.g. globalisation effect on the US “rust-belt”
2. International factors –e.g. part of a worldwide recession/slump;”
3. Failed government or Central Bank policy e.g. Austerity/high interest rates
4. Period of high inflation leading to economic uncertainty.

Question 6

What are the causes of a Positive Output Gap?

Answer 6

1. This may occur in a boom
2. Lower taxes
3. Low interest rates
4. Excessive business or consumer confidence
5. The back of deliberate fiscal expansion e.g. government investing large sums in infrastructure and other projects.

Question 7

What are the consequences to a Negative Output Gap?

Answer 7

1. Deflationary pressure on the economy (deflationary gap)
2. Increased unemployment
3. Lower tax revenue and more expenditure on benefits for government
4. Low levels of growth (even negative)

Question 8

What are the consequences to a Positive Output Gap?

Answer 8

1. Inflationary Pressure and the inflationary gap
2. Lots of worker overtime to meet demand for output
3. Immigrant labour for same reason
4. Higher tax revenue/low expenditure on benefits
5. Fast growth but danger of over-heating of the economy