hi everybody output gaps occur any time where the actual level of output is different from the potential level of output I.E it is not equal to the Full Employment level of output let's look at negative output gaps first a negative output Gap occurs anytime what actual output is less than the potential level of output this is also known as a deflationary gap and also known as a recessionary gap because you tend to see this when the economy is suffering from a recession let's look at the classical interpretation and a Kian interpretation of what a negative output Gap would look like on the classical model let's draw ad and Sr so there's SRS and there is ad now where they meet is the actual level of output right and that is at y1 with an inflation level a price level at P1 but crucially that output level is going to be less than the potential level of output so LR is going to be to the right of this equilibrium it's going to be over here somewhere okay so there is L RS and there is YF okay so the distance yeah the difference between y1 and YF is the negative output Gap or the deflationary gap or the recessionary Gap whatever you want to call it there it is right there actual level of output is less than the potential level of output what about a Keynesian interpretation well let's draw a Keynesian lrs curve which will look something like this okay there is YF full employment right there so ad would cut l r any point below YF so maybe over here so if that's ad then there is the actual level of output which is y1 and there is the price level P1 so again the difference between y1 and yfe is the negative output Gap or the deflationary gap or the recessionary Gap actual level of output is less than the potential level of output this is a negative Alpha Gap uh using a Keynesian lrs diagram what about a posit positive output Gap where a positive output Gap occurs where the actual level of output is greater than the potential level of output another name for this is an inflationary Gap how would classical Economist show it well let's let's show ad and SRS again so there is SRS and there is ad okay and where the two meet we have the actual level of output which is y1 and we have a price level of P1 but crucially now this output level is going to be greater than the potential level output so LR we can draw it over here somewhere and there is YF but you can see that the actual level of output is greater than the potential level of output how is that possible well remember what we said in previous videos it is possible for a short period of time for the economy to be producing beyond the Full Employment level of output because YF represents the maximum level of output that an economy can produce using all factors of production at sustainable level levels okay so it is possible to produce beyond that um we said that the YF value represents production that is taking place when the labor market is in full equilibrium I.E at the natural rate of unemployment so to produce y1 maybe we're taking workers out of the natural rate of unemployment maybe we are overusing labor unsustainable use of Labor maybe we're overusing Capital unsustainable use of capital to produce y1 the end result will be an overheating economy with prob very high inflation hence the term inflationary Gap is used as well as a positive app Gap it's very difficult to show it on a keynan diagram in fact it's impossible to show it perfectly uh according to this definition on a keynan diagram but in case you wanted to show it this is how you would do it so again a keian LR Cod and you would just show aggregate demand right at the top of the vertical part of Keynesian lrs I.E right at YF with a very high uh price level there okay now this doesn't fit the definition exactly I know that but it would still be accepted by an examiner this is the only way you can show it using a Keynesian interpretation here but if you had to draw a positive app Gap in the exam don't draw the Keynesian version draw the classical version where what you're showing clearly fits the definition this is output gaps what's very interesting is how you can use the idea of Apper gaps when it comes to evaluating key ideas in your essays let's see how you can do that well let's take an ad shift to the right maybe there's been an increase in real disposable income in the economy when ad shift to the right what conclusions do we normally make when we normally say look that um the actual level of growth will increase we say that because labor is a derived demand unemployment will decrease we say that there'll be a rise in demand P inflation and because of that a worsening of the trade position is exports become less competitive that's normally our conclusions but we can evaluate that we can critique that by using output gaps now what we can say is what if there is such a huge negative output Gap maybe the economy is in deep recession where ad is way down here yeah at y1 price level P1 a huge negative Apper Gap the difference between y1 and Y actual growth is much less than potential growth well if there is an increase in real disposable income in ad shift to the right there is not necessarily going to be an increase in inflation at all so if ad shift to the right and we go here to 82 you can see that yes we see the increase in actual growth yes we see the fall in unemployment but we don't see any impact on inflation whatsoever the price level remains at P1 however you could say if the economy was operating at full employment or very close to Full Employment and AD were to shift to the right due to a rise in real disposable income let's say then you might start to see a conflict so if ad shifted to ad3 for example then all right we get Maybe an increase in economic growth but with that we see the conflict of higher inflation and you can say if the economy is out full employment and AD shifts to the right there'll be no impact on growth no impact on unemployment there'll only be inflationary pressure so you can use output gaps to evaluate that way you can use the same idea if you're shifting ad left as well very useful evaluation when you're talking about the conflict of macroeconomic objectives and whether there will be a conflict or not let's do the same thing for LR s well what conclusions do we make for LR well we say that when LR shifts to the right there'll be an increase in both actual and potential growth uh there'll be a fall in unemployment the natural rate of unemployment will decrease we see that cost push inflationary pressure will decrease and with that exports become more competitive and maybe the trade position in the economy will improve too we make all of these assumptions whether you use the classical model to do it whether they use the Keynesian model to do it they are the conclusions we generally make but that doesn't have to be the case okay again what if there is a huge negative output Gap what if ad is very very low in the economy well let's take the classical interpretation of that okay and let's say that maybe ad is over here so that's ad and there's lrs and with that we have a price level P1 and there is y fe1 well what if L shifts but there isn't enough ad in the economy there isn't enough demand in the economy to make any use of that shift of lras so maybe L shifts over here well ad is not cutting the new lrs curve so there is going to be no change at all in the economy yeah so if lrs shifts without there being any aggregate demand out there in the economy to meet that new uh level of longrun aggregate supply there is going to be no change to equilibrium whatsoever in the economy yeah so all of the conclusions we came to are not going to take place we can show exactly the same thing on a Keynesian LS uh diagram as well so you know there's LR there and there is YF but if ad is way down here let's say with equilibrium of y1 and price level P1 what if LF shifts to over here to LR2 again there isn't enough aggregate demand in the economy in the first place to make any use of that such a large negative output Gap in the first place where by this shift of lrs is redundant yeah in this case what is needed not lrs shifting policies like supply side policies but demand side policies canes would argue a needed to get aggregate demand closer to the Full Employment level of output supply side policies in this case when the economy is in deep recession with a huge negative output Gap are going to be useless demand side policies are the only way in which the economy can grow so this is how you can use output gaps to evaluate the key conclusions that we come to whenever we shift ad or lrs whenever we talk about the impacts on macroeconomic perform performance outper gaps are always a fantastic evaluation tool for you to use so hope that makes sense hopefully now you can really nail the essays when you use appbook apps I will catch you all in the next video thank you so much for watching 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