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1.State three ways the ‘trend rate’ of growth may be presented (3)
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Technological advancement
Accumulation of capital stock
Increases in labor inputs
2.State three ways that the ‘output gap’ can be illustrated (3)
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Growth rate
Classical negative output gap
Classical positive output gap
3.State three disadvantages of a positive output gap (3)
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Demand-pull inflation
Trade problems
Labour shortages
4.State three advantages of a negative output gap (3)
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Economy is not reaching full capacity for output, so there is room to grow.
A negative output gap will typically cause low inflation
Bring to class with your output gap sheet
Q1 For 2 marks, define positive output gap:
A positive output gap occurs when actual output is more than full-capacity output.
This happens when demand is very high and, to meet that demand, factories and
workers operate far above their most efficient capacity.
For 2 marks, define negative output gap:
A negative output gap occurs when actual output is less than what an economy
could produce at full capacity. A negative gap means that there is spare capacity, or
slack, in the economy due to weak demand.
Q2
Output gaps are very difficult to measure. Can you write down 2 reasons why this is the case:
First reason: Output gap is hard to measure because we can't observe potential output.
Potential output relies heavily on relationships that are intertwined in the economy.
Second reason: There is no uniform way to measure potential output.
Q3
Based on your understanding of the economic cycle and output gaps, draw an economic cycle
diagram and label a point at which the economy has a positive output gap and a point at which the
economy has a negative output gap. (Remember: label curves and axes with care!)
Q4
If an economy runs large output gaps (positive or negative) for too long, problems can emerge. Fill in
the table below to show whether the problem/risk in the middle column is one usually associated
with positive or negative output gaps:
Positive Problem/Risk Negative
Output
Output
Gap
Gap
+
Increased
consumer
confidence
A reduction +
in taxation
revenue
Deflation
+
Government +
runs budget
deficits
+
Housing and
Equity
markets
bubbles
+
Demand Pull
Inflation
+
Current
Account
worsens
Q5
The UK was running a negative output gap during the recent recession. Explain the relationship
between a negative output gap and the two variables below:
Unemployment: Level of unemployment: higher unemployment increases the negative output gap.
A fall in unemployment implies economy getting closer to the level of full employment if actual GDP
is less than potential GDP there is a negative output gap. A negative output gap also causes a
worsening of government finances – we have seen in the current recession how badly tax revenues
have been affected by the slump in demand, profits and the subsequent rise in unemployment.