Output Gaps (Edexcel A Level Economics A)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
Actual Growth & Long-term Growth
Actual growth can be differentiated from the idea of long-term trends in growth rates
A long-term growth trend is the underlying trend rate of economic growth over a longer period of time
This is determined by the constant increases in the productive capacity of an economy (aggregate supply)
The increase in productive capacity is illustrated by a rightward shift of the long-run aggregate supply curve (LRAS)
Use of long-term growth trends can reduce the impact of outliers in the data
Positive & Negative Output Gaps
An output gap is the difference between the actual level of output (real GDP) and the maximum potential level of output
A positive output gap occurs when real GDP is greater than the potential real GDP
A negative output gap occurs when the real GDP is less than the potential real GDP
There is spare capacity in the economy to produce more goods/services than are being produced
It is difficult to measure output gaps accurately
This is because it is hard to know exactly what the maximum productive potential of an economy is
Rapidly rising prices can indicate a positive gap is developing
Rising unemployment and slowdown in economic growth can indicate that a negative gap is increasing
A negative output gap
Diagram analysis
The potential output of this economy is at YFE
The economy is in a short-run equilibrium at AP1Y1
A negative output gap exists at Y1 - YFE
This effectively gives the economy sparer capacity in the short-term
One cause of this may be that the AD has recently decreased due to a fall in consumption
The Classical view is that the output will return to YFE in the long-run, but at a lower average price level
The Keynesian view is that an economy may be stuck in a negative output gap for a long period of time
A positive output gap
Diagram analysis
The potential output of this economy is at YFE
The economy is in a short-run equilibrium at AP1Y1
A positive output gap exists at YFE - Y1
This effectively gives the economy more productive capacity in the short-term
One cause of this may be that workers are willing to work overtime once full capacity is reached
It is not sustainable and the Classical view is that the output will return to YFE, but at a higher price level
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