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Output Gap Output Gap The output gap is the difference between the actual level of national output and its potential level and is usually expressed as a percentage of the level of potential output Negative deflation. If output gap – Low inflation or actual GDP is less than potential GDP there is a negative output gap. Some factor resources such as labour and capital machinery are under-utilized and the main problem is likely to be higher than average unemployment. A rising number of people out of work indicate an excess supply of labour, which causes pressure on real wage rates. Real wages are likely to decrease when there is high unemployment. Positive inflation • output gap – upward pressure on If actual GDP is greater than potential GDP then there is a positive output gap. • Some resources including labour are likely to be working beyond their normal capacity e.g. making extra use of shift work and overtime • The main problem is likely to be an acceleration of demand-pull and costpush inflation. • A positive output gap is associated with countries where an economy is overheating because of fast and rising demand - a good example of this might be countries such as India and China What Determines Size of Output Gap? 1.Level of unemployment. Higher unemployment increases the negative output gap. 2.Levels of spare capacity. If firms report they are under-utilising capacity, there is a bigger negative output gap. What determines the size of the output gap? 3.Productivity growth. If productivity growth falls, this decreases the growth of potential ouptut and therefore limits the negative output gap. 4.Inflation. Inflation can be a guide to the output gap. If inflation is high and firms pushing up prices, this suggests there is a positive output gap.