Output gap

An output gap is said to exist when an economy is not producing at full capacity. So a negative output gap occurs when the economy’s actual output bellows its potential output. Illustrating the negative output using PPF diagram, the point has to lie within the curve, which means that the economy is not using all of its capacity.

Some problem might rise from it. The economy doesn’t achieve the allocative and productive efficiency. The productivity of workers might be low or there is the wrong target of producing, when the supply doesn’t meet the demand in market, or we can say that the consumer satisfaction isn’t maximised.



But I think the output gap is not so harmful for the economy. Well it’s not when the gap is not so large. When there is an output gap, it will lower the inflationary pressure for the economy. The economy can increase their output without rising in price level because they have capacity. We might say that when the negative output occurs, there is a high level of unemployment, because the economy doesn’t use all of its resources, here is workers. It might not be true because some people work as waitresses, bankers, bus-drivers, street cleaners, and teachers as well, doesn’t actually ‘produce’. Therefore their contribution will not take into account of output of the economy.

When the output gap is getting wider, we can assume that the economy is failing to achieve the allocative and productive efficiency. To deal with it, the government might use the supply side policy. Training is needed more to increase workers productivity. Or government might subsidise firms to reduce their production cost, therefore they can produce more.

In the other hand, the positive output arises when an economy’s actual output is higher than its potential output. It seems to be impossible because when the economy is at full capacity, the output will not raise even the aggregate demand shifts to the right. For a short time, however, an economy might be able to produce more if workers work overtime, some people who are not usually in the labour force enters it, and machinery is used flat out. It contains a danger of inflationary and it can’t be hold for a long run, according to the diminishing returns law unless the economy potential output increase.