Output Gaps
Output Gaps
Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
Output Gaps
An output gap is the difference between actual output and potential output. It is an indicator that the country is not using its resources effectively
- Positive Output Gap – the economic growth is higher than the trend rate and hence is causing inflation
- Negative Output Gap – suggests an economic downturn where unemployment is rising and there is space capacity
- The Trend Rate is determined by the growth of productivity and the long-run aggregate supply
Reasons for an Output Gap occurring
- When demand is high and there are not resources available to meet the needs of the economy
- The Welfare Benefit System which pays unemployed individuals generously leading to a wastage of resources
- Increased competitiveness of other countries
- Relocation or expanding of business to other countries
Factors determining the size of an Output Gap
- Inflation – the higher the inflation, the more positive the output gap will be
- Employment – higher unemployment increases the negative output gap
- Firms recruiting less workers – firms not being able to fill job vacancies suggests a positive output gap
- Productivity Growth – a fall in productivity growth decreases the growth of potential output and limits the negative output gap
The distinction between Actual Growth Rates and Long-Term Trends in Growth Rates
- Long-Term Trend in Growth Rate – the average sustainable rate of economic growth over a period of time
- Actual Growth Rate – the actual change in Real GDP over time; the business cycle is made up of the changes in the Actual Growth Rate
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Difficulties in measuring Output Gaps
- Estimates may not always be accurate as the structure of the economy is constantly changing
- Inflationary effects of a positive output gap may be offset by changes in the exchange rate
- Using data from past trends may lead to uncertainties and hence data is not always reliable
Quick Fire Quiz – Knowledge Check
1. Define ‘Output Gaps’ (2 marks)
2. Distinguish between a Positive Output Gap and a Negative Output Gap (4 marks)
3. Explain four reasons for why an Output Gap may occur (4 marks)
4. Draw a diagram showing a Positive Output Gap (4 marks)
5. Draw a diagram showing a Negative Output Gap (4 marks)
6. Identify and explain four factors determining the size of an Output Gap (8 marks)
7. Explain the distinction between Actual Growth Rates and Long-Term Trends in Growth Rates (4 marks)
Next Revision Topics
- Economic Growth
- Aggregate Demand
- Aggregate Supply
- Exports / Imports
- Equilibrium Levels of Real National Output
- Circular Flow of Income
- Gross National Income
- Trade Cycle
- The Multiplier
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