Output Gaps

Question 1

Negative output gap

Answer 1

Using the classical AD/AS
model:
* Equilibrium income is at
Y1, where AD=SRAS. This
is the actual output.
* Yfe represents the
economy’s potential
output.
* The gap between Y1 and
Yfe is the negative output
gap. There are some unemployed resources. A rise in AD could
help close the gap

Question 2

Positive output gap

Answer 2

Using the classical AD/AS
model:
* Equilibrium income is at
Y1, where AD=SRAS. This
is the actual output.
* Yfe represents the
economy’s potential
output.
* The gap between Y1 and
Yfe is the positive output
gap. A positive output increases the competition for scarce resources;
wages and other business costs start to rise, SRAS will shift left
until the economy returns to Yfe. (Cost-push inflation)

Question 3

Negative output gap

Answer 3

Using the Keynesian AD/AS model:
* Equilibrium income is at Y1, where
AD=SRAS. This is the actual output.
* Yfe represents the economy’s
potential output or full employment
income
* The gap between Y1 and Yfe is the
negative output gap
* An increase in AD to AD2 reduces the
size of the negative output gap
from Y1Yfe to Y2Yfe

Question 4

Difficulties measuring the output gap

Answer 4

Measuring the output gap in an economy is challenging:
* It involves determining potential output, which is not directly observable
* It is influenced by evolving factors like technological changes and demographic
shifts
* Accurate data on current output levels is often subject to revisions
* Economic uncertainty means it is hard to make precise measurements

Question 5

Sustainable growth

Answer 5

• Growth which can continue into the long run
• Growth without using up non-replaceable resources
• No natural resources depletion or degradation (environmentally-friendly)
• Growth which does not compromise future generations

Question 6

Inclusive growth

Answer 6

• Growth where all citizens experience an increase in their income/living standard
• Income inequality does not cause some groups to miss out on the benefits of
  growth
• Most economists do not believe that the benefits of growth will ‘trickle down’
  from rich to poor without government intervention