Summary
An output gap is the difference between the actual level of economic output (GDP) and the potential level of output that an economy could produce at full employment. Example: Economists use output gaps to assess whether an economy is operating above or below its capacity.
- Positive Output Gap — occurs when actual GDP exceeds potential GDP, indicating full utilization of resources and potential inflationary pressures. Example: A surge in consumer spending can push GDP beyond sustainable levels, creating a positive output gap.
- Negative Output Gap — happens when actual GDP is below potential GDP, showing underutilization of resources and economic downturn. Example: During a recession, decreased demand can cause GDP to fall below potential, resulting in a negative output gap.
- Demand-Side Shocks — sudden changes in consumer spending, investment, or government expenditure affecting output gaps. Example: A sudden increase in government spending can create a positive output gap.
- Supply-Side Shocks — disruptions in technology, labor productivity, or resource availability impacting potential output. Example: A technological advancement can increase potential output, affecting the output gap.
Exam Tips
Key Definitions to Remember
- Output Gap
- Positive Output Gap
- Negative Output Gap
Common Confusions
- Confusing positive output gaps with economic growth
- Misunderstanding the role of demand-side and supply-side shocks
Typical Exam Questions
- What is an output gap? An output gap is the difference between actual GDP and potential GDP.
- What is the distinction between actual and potential growth? Actual growth refers to the increase in GDP, while potential growth is the increase in the economy's capacity to produce.
- Demonstrate a positive output gap with an AD/AS diagram. Show actual GDP exceeding potential GDP on the diagram.
What Examiners Usually Test
- Understanding of output gaps and their economic implications
- Ability to analyze causes and consequences of output gaps
- Application of AD/AS diagrams to illustrate output gaps