Unit 2 Macro: The Output Gap | tutor2u Economics

How much spare capacity does an economy have to meet a rise in demand? How close is an economy to operating at its productive potential? Has the recession damaged the economy’s productive potential? These sorts of questions all link to an important concept – the output gap. The output gap is the difference between the actual level of national output and the estimated potential level and is usually expressed as a percentage of the level of potential output.

Negative output gap – downward pressure on inflation

If 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. We have seen millions of people in the labour market have to accept lower pay rises in recent years, many have seen wage freezes or actual wage cuts at a time when businesses have been under huge pressure to control their costs.

Data from Timetric.

To view this graph, please install Adobe Flash Player.

OECD Economic Outlook Database (version 88) from Timetric

Positive output gap – upward pressure on inflation

• 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 cost-push inflation.
• A positive output gap is associated with countries where an economy is over-heating because of fast and rising demand - a good example of this might be countries such as India and China

 

Subscribe to email updates from the tutor2u Economics

Join 1000s of fellow Economics teachers and students all getting the tutor2u Economics team's latest resources and support delivered fresh in their inbox every morning.

You can also follow @tutor2uEconomics on Twitter, subscribe to our YouTube channel, or join our popular Facebook Groups.

Teaching Vacancies

Recruitment

Advertise your vacancies with tutor2u

Much cheaper & more effective than TES or the Guardian. Reach the audience you really want to apply for your teaching vacancy by posting directly to our website and related social media audiences.

Find our more ›

Advertise your teaching jobs with tutor2u

A New Home for tutor2u Resources

We've just flicked the switch on moving all our digital resources to instant digital download - via our new subject stores.

For every subject you can now access each digital resource as soon as it is ordered. This will always be the latest edition of each resource too (and we'll update you automatically if there is an upgraded version to use).

Simply add the required resources to your cart, checkout using the usual options and your resources will be available to access immediately via your mytutor2u account.