2.5.2 Output gaps Quiz: Pearson Edexcel Economics A, Unit 2

The 20 questions

1. An output gap is best defined as:

   • the difference between exports and imports of goods and services
   • the difference between the long-run and short-run AS curves at a given price level
   • the difference between nominal GDP and real GDP in a given year
   • the difference between actual real output and potential real output

2. A negative output gap indicates that:

   • actual output is below potential output, so the economy has spare capacity
   • potential output has fallen below actual output
   • actual output is above potential output, so the economy faces inflationary pressure
   • the price level is at its lowest possible value

3. A positive output gap is most likely to lead to:

   • upward pressure on prices and wages as resources are used beyond their sustainable level
   • a fall in unemployment and a fall in real wages, because strong demand creates jobs while falling real pay cuts the cost of hiring
   • falling prices and wages as firms cut production, because demand above capacity causes stocks to build up and firms to cut prices
   • no pressure on prices because demand is fully met, so firms have no reason to change their prices or pay when output exceeds potential

4. On an AD/AS diagram, a negative output gap is shown by:

   • equilibrium real output to the right of the LRAS curve
   • an equilibrium where AD is to the left of the origin
   • the LRAS curve shifting to the right of the SRAS curve
   • equilibrium real output to the left of the LRAS curve

5. Using an AD/AS diagram, a positive output gap is illustrated by:

   • a leftward shift of AD with LRAS unchanged
   • equilibrium real output to the right of the LRAS curve, with a higher price level
   • equilibrium output equal to the LRAS curve with no change in prices
   • equilibrium real output to the left of the LRAS curve, with a lower price level

6. Which statement about measuring output gaps is most accurate?

   • Potential output is not directly observable, so output gap estimates are uncertain and revised over time
   • Output gaps can be measured precisely from the claimant count alone, since benefit claims show exactly how far output is from potential
   • Potential output is measured exactly by the government each year, so output gaps are published without any margin of error or revision
   • Output gaps are always zero by definition in every economy, because potential output is defined as whatever output the economy produces

7. If actual GDP is 1,080 and potential GDP is 1,000, what is the output gap as a percentage of potential output?

   • -8%
   • 1.08%
   • 80%
   • 8%

8. A recession leaves GDP at 950 against potential GDP of 1,000. What is the output gap as a percentage of potential?

   • -50%
   • -5%
   • 5%
   • -0.95%

9. Which is the most likely effect of a large negative output gap on unemployment?

   • unemployment is unaffected because the output gap only affects prices
   • unemployment tends to fall because firms need more labour when output is low
   • unemployment tends to rise because firms have spare capacity and reduce their demand for labour
   • unemployment falls because workers leave the labour market in large numbers

10. Which statement about the implications of a positive output gap for policy is most accurate?

    • A positive gap can only be reduced by a fall in potential output, since demand management cannot affect output at full capacity
    • Policy-makers should always increase demand to widen the gap further, because a bigger positive gap means more people are employed
    • A positive gap means no policy is needed because prices are stable, so the economy can keep operating above potential without risk
    • Policy-makers may seek to cool demand to limit inflationary pressure, though the output gap estimate is uncertain

11. Which of these is most likely to cause a positive output gap in the short run?

    • a rise in unemployment caused by a recession in trading partners
    • a rise in aggregate demand that moves actual output above potential
    • a fall in the long-run productive capacity of the economy
    • a fall in aggregate demand that moves actual output below potential

12. Which statement best explains why measuring the output gap is difficult?

    • Potential output is set by the government in the budget each year, so the gap is a political choice rather than a measurable quantity
    • The output gap depends only on the exchange rate, which is easy to measure, so the gap can be estimated accurately from currency data
    • Output is observed exactly, so the only difficulty is measuring prices, which are revised by statistical agencies every quarter
    • Potential output depends on unobservable factors such as productivity trends and the natural rate of unemployment

13. Actual output is 2,000 and potential output is 2,100. Which best describes the economy?

    • a negative output gap of about 4.8% of potential output
    • a zero output gap because output is close to potential
    • a negative output gap of 100 units, equal to 50% of output
    • a positive output gap of 5% of potential output

14. Why might a government be cautious about relying on output gap estimates?

    • Estimates of potential output are revised as new data arrive, so the gap may be mismeasured in real time
    • Output gaps are irrelevant because only the price level matters for policy, so estimates of spare capacity have no bearing on decisions
    • Estimates are always perfectly accurate, so governments can base fiscal decisions on the published gap without any revision
    • Output gaps can only be measured using the balance of payments, so the estimates depend on trade data published with long delays

15. Potential output is 500 billion and actual output is 525 billion. What is the output gap as a percentage of potential output?

    • +5%
    • +0.05%
    • -5%
    • +25%

16. Actual GDP is 1,200 and potential GDP is 1,250. What is the output gap as a percentage of potential GDP?

    • -0.4%
    • 4%
    • -50%
    • -4%

17. Which statement best explains why a large positive output gap can be inflationary?

    • Demand exceeds productive capacity, so firms bid up input prices and raise selling prices
    • Unemployment rises, pushing wages down and reducing costs for firms, so a positive output gap reduces inflation through lower pay
    • Demand falls below supply, so firms lower prices to attract buyers, which reduces the pressure on costs and keeps prices stable
    • Output rises while input costs fall, because firms gain productivity from high demand, which reduces the pressure on prices

18. In a recession, which statement about the output gap is most likely?

    • the output gap is positive as firms raise capacity utilisation
    • the output gap is positive because prices are falling across the economy
    • the output gap is negative as spare capacity and unemployment increase
    • the output gap is zero by definition during any recession

19. Why do governments measure output gaps when setting fiscal policy?

    • to judge whether demand is above or below sustainable capacity, and so whether stimulus or restraint may be appropriate
    • to calculate household spending on food and fuel only, so that welfare payments can be adjusted to basic living costs
    • to measure the exact size of the national debt in each year, so that borrowing limits can be set on the amount owed to bondholders
    • to set the price of imported goods in sterling terms, so that the government can control the cost of goods bought by households

20. Potential output grows by 2% a year for two years while actual output stays unchanged. What happens to the output gap, all else equal?

    • It is unchanged, because actual output has not changed
    • It becomes more positive, by about 4% of potential output
    • It becomes zero, because potential output falls back
    • It becomes more negative, by roughly 4% of potential output

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