• Actual growth?can be differentiated from the idea of?long-term trends?in growth rates
• A long-term growth trend is the underlying?trend rate of economic growth?over a longer period of time
  • This is determined by the?constant increases?in the?productive capacity of an economy (aggregate supply)
    • The increase in?productive capacity?is illustrated by a rightward shift of the long-run aggregate supply curve (LRAS)
  • Use of long-term growth trends can reduce the?impact of outliers?in the data

• An?output gap?is the difference between the?actual level?of output?(real GDP)?and the?maximum potential?level of output
  • A?positive output gap?occurs when real GDP is greater than the potential real GDP
  • A?negative output gap?occurs when the real GDP is less than the potential real GDP
    • There is?spare capacity?in the economy to produce more goods/services than are being produced
• It is?difficult to measure output gaps?accurately
  • This is because it is hard to know exactly what the?maximum productive potential?of an economy is
  • Rapidly rising prices?can indicate a?positive gap?is developing
  • Rising unemployment?and?slowdown?in economic growth can indicate that a?negative gap is increasing

A Negative Output Gap

An Keynesian (top) and Classical (bottom) diagram illustrating an economy that has a negative output gap (Y1- YFE) and is currently producing less than its potential output

Diagram Analysis

• The potential output of this economy is at?YFE
• The economy is in a?short-run equilibrium?at AP1Y1
  • A negative output gap exists at?Y1?- YFE
    • This effectively gives the economy?sparer capacity?in the short-term
  • One cause of this may be that the?AD has recently decreased?due to a fall in consumption
  • The?Classical view?is that the output will return to?YFE??in the long-run, but at a?lower average price level
  • The?Keynesian view?is that an economy may be stuck in a?negative output gap?for a long period of time

A Positive Output Gap

An AD/AS diagram illustrating an economy that has a positive output gap (YFE?- Y1) and is currently producing more than its potential output

Diagram Analysis

• The?potential output?of this economy is at?YFE
• The economy is in a?short-run equilibrium?at AP1Y1
  • A positive output gap exists at?YFE?- Y1
    • This effectively gives the economy?more productive?capacity?in the short-term
  • One cause of this may be that workers are willing to?work overtime?once full capacity is reached
    • It is?not sustainable?and the?Classical view?is that the output will return to?YFE,?but at a?higher price level