Output Gaps

Output Gaps

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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

IAL Spec – Additional Content

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)


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