ESSAY: evaluate with an appropriate diagram whether reducing a negative output gap will always improve macroeconomic performance

Question 1

Definitions of negative output gap and macroeconomic performance

Answer 1

Negative output gap- difference between potential output and real output
Macroeconomic performance- how well the government is able to achieve its 5 macroeconomic objectives

Question 2

Why it can improve macroeconomic performance with diagram

Answer 2

-Economic growth being one the main objectives and closing the gap should ensure that economic growth is maximised given the capacity of the economy
-utilising more factors of production can increase employment levels, another important factor, more human capital to employ who’s job it is to maintain, sell, run etc all other factors of production, increasing output
-less chance of deflation, effect on confidence etc
DIAGRAM= PPF or AD AS showing movement towards the inelastic LRAS part

Question 3

Why it can be harmful for macroeconomic performance with diagram

Answer 3

-fixing and exceeding an output gap can lead to excessive inflation, both cost push and demand pull, a main macroeconomic policy that is pursued by the bank of England
-may have to raise interest rates which decreases investment and maybe curtails an economic boom
-no further increase in GDP but inflation occurs
DIAGRAM= LRAS and AD curves with AD on perfectly inelastic part showing inflation

Question 4

What it depends on?

Answer 4

• Whether it ALWAYS improves performance, clearly it doesn’t always and this can be dependant on the size of the gap and therefore the position of the economy/ AD curve
• how favourable each objective is, if they are pursuing economic growth and low unemployment above all else then its better than if they were hugely worried about inflation of 2%