ILO:
a) Distinction between actual growth rates and long-term trends in growth rates
b) Understanding of positive and negative output gaps and the difficulties of measurement
c) Use of an AD/AS diagram to illustrate an output gap (level of spare capacity) in an economy
a) Distinction between actual growth rates and long-term trends in growth rates
b) Understanding of positive and negative output gaps and the difficulties of measurement
c) Use of an AD/AS diagram to illustrate an output gap (level of spare capacity) in an economy
Actual growth rates & long-term trends in growth rates
Trends in the growth rate are shown by changes in real GDP over time; these may be compared with changes in capacity over time or compared with the trend or sustainable rate of growth.
How could we illustrate the difference between actual growth and long-term trend in growth using a diagram?
How could we illustrate the difference between actual growth and long-term trend in growth using a diagram?
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Explain when an economy would need Govt intervention?
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Positive and Negative output gaps
The difference between actual real GDP and maximum potential real GDP is the output gap.
If actual real GDP is less than potential real GDP, then there is a negative output gap. This signifies that the economy is operating with spare capacity and unemployment is likely to be relatively high.
In the short run, it may be possible for actual real GDP to be greater than potential real GDP: a positive output gap. In this case, the economy is operating at over-capacity and inflationary pressures are likely to be increasing.
If actual real GDP is less than potential real GDP, then there is a negative output gap. This signifies that the economy is operating with spare capacity and unemployment is likely to be relatively high.
In the short run, it may be possible for actual real GDP to be greater than potential real GDP: a positive output gap. In this case, the economy is operating at over-capacity and inflationary pressures are likely to be increasing.
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Keynesian economists
believe that a negative output gap can exist in the long run as well as the short run:
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Classical economists
believe that in the long run all markets will clear therefore a negative and positive output gaps can only exist in the short run:
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Explain what is meant by an output gap. (5 marks)
Why Australia Hasn't Had A Recession In Decades
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Examine two causes of a negative output gap. (8 marks)
UK Chancellor warns of “economic emergency” with worst downturn for 300 years - BBC News
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Difficulties of measurement
It is very difficult to estimate the size of the output gap for an economy, as it involves estimating the economy’s maximum potential output level.
Potential output may be estimated using a production function approach or a statistical approach, but there are measurement issues associated with both. For the advanced economies, potential output is usually calculated using a production function approach, based on estimates of labour supply, capital stock and total factor productivity.Thus, any output gap measure constructed using this methodology would reflect measurement error for each of these variables.
Estimating the output gap of an emerging market economy poses additional challenges. There are significant data-quality issues for most emerging market economies.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb080304.pdf
Potential output may be estimated using a production function approach or a statistical approach, but there are measurement issues associated with both. For the advanced economies, potential output is usually calculated using a production function approach, based on estimates of labour supply, capital stock and total factor productivity.Thus, any output gap measure constructed using this methodology would reflect measurement error for each of these variables.
Estimating the output gap of an emerging market economy poses additional challenges. There are significant data-quality issues for most emerging market economies.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb080304.pdf
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Assess the importance in understanding the output gap for a country like China when deciding upon macro policy?
(10 marks)
(10 marks)
China wage growth is soaring | World
Revision material
Watch and read the materiel below:
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Y1/IB 28) Output Gaps
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Output Gap and the Economic Cycle I A-Level and IB Economics
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| what_is_the_output_gap.pdf |