OUTPUT GAPS

• A negative output gap is seen when the economy is suffering from a recession
• When aggregate demand shifts to the right, it indicates an increase in real disposable income in the economy
• A positive output gap occurs when the actual level of output is greater than the potential level of output, also known as an inflationary gap
• In classical economics, a positive output gap means the actual output is greater than the potential level of output
• A positive output gap can lead to an overheating economy with high inflation
• In classical economic theory, a negative output gap means the actual output is less than the potential level of output
• Output gaps occur anytime where the actual level of output is different from the potential level of output
• In a Keynesian interpretation, a negative output gap occurs when the actual output is less than the potential level of output
• A negative output gap occurs when the actual output is less than the potential level of output, also known as a deflationary gap or recessionary gap
• It is possible for the economy to produce beyond the Full Employment level of output for a short period, resulting in a positive output gap
• Conclusions of an increase in real disposable income due to a rightward shift in aggregate demand include: increased actual growth, decreased unemployment, rise in demand-pull inflation, and a worsened trade position as exports become less competitive
• If there is a huge negative output gap, the economy may be in deep recession
• Rise in demand

  Inflation
• Exports may become more competitive and the trade position may improve when LRAS shifts to the right
• If the economy is at full employment and AD shifts to the right, there may be inflationary pressure
• Unemployment will decrease

  Rise in demand
• Supply side policies may be ineffective in deep recession with a huge negative output gap, and demand side policies may be necessary for economic growth
• Output gaps are a valuable tool for evaluating the impacts of shifting AD or LRAS on macroeconomic performance
• Shift in AD to the right may lead to increased growth and fall in unemployment without impacting inflation
• Output gaps can be used to evaluate conclusions and critique assumptions
• When LRAS shifts to the right, there may be an increase in actual and potential growth, a fall in unemployment, and a decrease in cost-push inflationary pressure
• Growth will increase

  Labor is a derived demand
• An increase in real disposable income and AD shift to the right may not necessarily lead to an increase in inflation
• Inflation

  Worsening of the trade position as exports become less competitive
• Output gaps are useful for evaluating conflicts in macroeconomic objectives
• If LR shifts without sufficient aggregate demand, there may be no change in the economy