Output Gaps Flashcards
What is an output gap?
The difference between an economy’s actual output (real GDP) and its potential output (trend output) at a given point in time.
What is a negative output gap?
It occurs when actual output is below potential output, indicating underutilisation of resources such as high unemployment and low capacity utilisation.
What is a positive output gap?
It occurs when actual output exceeds potential output, suggesting overutilisation of resources like inflationary pressures and an overworked labour force.
What are the key phases of the economic cycle related to output gaps?
Alternating periods of economic expansion (upswings) and contraction (downswings), aligned with fluctuations in output gaps.
What is trend output?
The economy’s long-run average growth path, often aligned with its potential output.
In Figure 7.8 (standard economic cycle), what is indicated between points A (trough) and B (trend)?
A negative output gap, where actual output is below trend output.
In Figure 7.8 (standard economic cycle), what is indicated between points C (peak) and D (trend)?
A positive output gap, where actual output is above trend output.
What does Figure 7.9 (economic cycle when short run growth remains +) illustrate about output gaps and recessions?
Downswings in the economic cycle don’t always lead to recessions; growth can slow without becoming negative
Provide an example of a period with fluctuating output gaps but no recession.
The UK from 1993–2007, which saw output gap fluctuations but no recession until 2008-09.
When do economic cycles begin and end in relation to output gaps?
Economic cycles begin and end when output gaps close, as shown in points X to Z.
In an AD/AS diagram, where is a negative output gap located?
When actual GDP is to the left of the Long-Run Aggregate Supply (LRAS) curve.
What are the symptoms of a negative output gap?
High unemployment, unused capacity, and low inflation or deflation.
In an AD/AS diagram, where is a positive output gap located
When actual GDP is to the right of the LRAS curve.
What are the symptoms of a positive output gap?
An overheating economy, inflationary pressures, and unsustainable production.
What is hysteresis in the context of output gaps?
The long-term damage to an economy’s potential output due to severe economic downturns.
What are the causes of hysteresis?
Loss of productive capacity (e.g., business closures, capital depreciation) and long-term unemployment leading to skill erosion or mismatch.
What was the impact of the 2008-09 Great Recession on the UK economy?
UK GDP fell sharply and only returned to pre-recession levels by 2014, with potential GDP never fully regained, indicating a permanent loss.
What does Okun’s Law state about output gaps?
It links changes in output gaps to changes in unemployment, with negative output gaps often correlating with rising unemployment rates.
How does the Phillips Curve relate to output gaps?
It demonstrates the trade-off between inflation and unemployment, relevant for understanding how positive or negative output gaps affect inflationary pressures.
What is the Keynesian perspective on output gaps?
Keynesians focus on demand-side solutions to close gaps, such as fiscal stimulus or monetary policy.
What is the Classical perspective on output gaps?
Classical economists argue that output gaps will self-correct through wage and price adjustments.
What are policy responses to a negative output gap?
Expansionary fiscal or monetary policies, such as cutting interest rates or increasing government spending.
What are policy responses to a positive output gap?
Contractionary policies to curb inflation, such as raising taxes or increasing interest rates.
How did the 2008-09 Great Recession demonstrate hysteresis effects?
Declining labor force participation and sluggish productivity growth persisted long after the crisis.
What was the global economic impact of the COVID-19 pandemic regarding output gaps?
Sharp negative output gaps emerged due to lockdowns, prompting significant policy interventions to mitigate long-term damage.
What are the key diagrams to master for understanding output gaps?
- Figure 7.8: Economic cycle with negative and positive gaps.
- Figure 7.9: Non-recession downswings.
- Figure 7.10: AD/AS diagram distinguishing gaps relative to LRAS.
- Figure 7.11: Hysteresis effects comparing recovery to potential output
What are exam tips for output gaps?
Use clear, labeled diagrams, link theory to real-world examples, and evaluate policies considering trade-offs, time lags, and unintended consequences.
