Skip to content

Course home

Sign up

9.2.2 positive and negative output gaps

Definition

Output gap: the difference between actual output and potential (trend) output.

Positive output gap: when actual output is above the trend level.

Negative output gap: when actual output is below the trend level.

Showing gaps on a diagram

  1. On a trend-output chart, the gap is the vertical distance of actual output from the long-run trend.
  2. On an AD/AS diagram, a positive gap shows output beyond the full-capacity level and a negative gap shows output below it, with axes average price level and real output.
  3. A negative gap can also be shown as a point inside the production possibility curve.

Diagram showing positive and negative output gaps as the vertical distance of actual output from the long-run trend line.

Example
  • Actual output is £520bn while potential is £500bn, so output is 4% above trend.
gap=actual−potentialpotential×100=520−500500×100=4 \text{gap} = \dfrac{\text{actual} - \text{potential}}{\text{potential}} \times 100 = \dfrac{520 - 500}{500} \times 100 = 4 gap=potentialactual−potential​×100=500520−500​×100=4
  • A positive gap of 4% signals an overheating economy, as during China's boom in the mid-2000s, with building inflationary pressure.

What each gap implies

  1. A positive gap means demand is running ahead of capacity, so scarce resources bid up wages and prices, generating demand-pull inflation.
  2. A negative gap means spare capacity, so unemployment is higher and price pressure is weak.
  3. Output gaps therefore link directly to the twin problems of inflation and unemployment.
Example
  • In a recession actual output falls to £475bn against potential of £500bn, 5% below trend.
gap=475−500500×100=−5 \text{gap} = \dfrac{475 - 500}{500} \times 100 = -5 gap=500475−500​×100=−5
  • A negative gap of 5% means idle resources and rising unemployment, as in the United States during the 2009 recession.

Why gaps guide policy

  1. A positive gap can prompt tighter policy, such as higher interest rates, to curb inflation.
  2. A negative gap can prompt looser policy to support demand and reabsorb idle resources.
  3. A large negative gap suggests room to raise demand without much inflation, whereas a positive gap warns that extra demand may just raise prices.
Note
  • Output gaps help judge which stage of the business cycle the economy is in.
  • The right response depends on the size of the gap and on how reliable the estimate is.

Why gaps are hard to measure

  1. Potential output cannot be observed directly, only estimated.
  2. So estimates of the gap are uncertain and are revised as more data arrive.
  3. On balance, output gaps are a useful guide to the cycle, but the measurement difficulty means they should inform, not dictate, policy.
Exam technique
  • Define the gap as actual output − potential output.
  • Link a positive gap to inflation and a negative gap to unemployment, and show it on an AD/AS diagram.
Common Mistake
  • Do not confuse a negative output gap with negative economic growth; a negative gap is a level below potential, not a fall in output.
  • Do not treat a measured output gap as precise.
Self review
  • Define an output gap.
  • What is a positive output gap and what does it imply for inflation?
  • Calculate the gap when actual output is £520bn and potential is £500bn.
  • Why are output gaps hard to measure?
  • How does a negative output gap differ from negative growth?
PreviousNext

How was this guide?

Teach Genie

Review 9.2.2 positive and negative output gaps by teaching Genie

Teach it back in your own words, spot gaps, and remember it better.

Start teaching
Genie and Baby Genie

Lesson

Recap your knowledge with an interactive lesson

9 minute activity

Start lesson

An output gap is the difference between an economy's actual output and its potential output. Potential output, also called trend output, is the sustainable level of real output when resources are normally employed.

A positive output gap exists when actual output is above potential output. A negative output gap exists when actual output is below potential output.

The percentage output gap is calculated using the following formula:

Output gap=actual output−potential outputpotential output×100 \text{Output gap} = \frac{\text{actual output} - \text{potential output}}{\text{potential output}} \times 100 Output gap=potential outputactual output−potential output​×100

A positive result indicates a positive output gap, while a negative result indicates a negative output gap.

Flashcards

Remember key concepts with flashcards

23 flashcards

Practice flashcards

What is an output gap?

9.2.2 positive and negative output gaps Revision Guide

  1. Intl A Level
  2. /Economics
  3. /9.2.2 positive and negative output gaps

Revision notes for CIE Intl A Level Economics 9.2.2 positive and negative output gaps: explanations and worked examples.

Revision guides