Output Gap and the Economic Cycle

This updated video explores the concept and measurement of the output gap using AD-AS analysis and UK economic data.

What is the output gap?

• The output gap is the difference between the actual level of GDP and its estimated potential level.
• The output gap is usually measured as a percentage of the level of potential output.

Negative output gap

• When actual GDP is less than potential GDP
• Some factor resources are under-utilized e.g. there is some demand-deficient unemployment in labour market
• Main problem is likely to be rising unemployment and possible deflation risk

Positive output gap

• Actual GDP is greater than the estimated potential GDP
• Some resources are working beyond their usual capacity (e.g. extra shift work & overtime)
• Main problem is rising demand-pull and cost-push inflationary pressures