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ECON1102 MACROECONOMICS 1
Tutorial Test No. 2
Time Allowed: 20 mins
Question 1
(i) Explain the concept of potential output and why actual output can differ from potential output? (2 marks)
Potential output is not the same as actual output.
Potential output also known as potential GDP or Full Employment output and notated as y*, is the level of GDP an economy can produce using its resources i.e. labour and capital at normal rates and is unsustainable.
Whereas, actual output notated as y, can vary i.e. expand or contract due to changes in potential output. Therefore, in the short-run due to the changes in the utilisation rate of labour and capital, as actual output is dependent on the change in potential output they may differ.
As stated above, the two may differ and the difference is called an output gap.
Where if:
Positive output gap y > y*, it is called an expansionary gap
OR
Negative output gap y < y*, it is called a contractionary gap.
(ii) Identify two factors that might cause a change in the level of potential output. For each factor briefly explain why they can affect potential output. (2 marks)
Two factors that can cause a change in the level of potential output are the development and use of new technology or an ageing workforce.
Under the assumption that the country is using its resources at normal rates, so that actual output equals potential output, a significant fall in potential output growth would tend to result in recession. Similarly, an increase in technological innovation would result in the growth in potential output and hence lead to an economic expansion or even a boom. An example of this is in the 1990s, where there was an economic boom in the US, which was propelled by the technologies such as the Internet.
Another example is the severe slowdown in Japan also during the 1990s reflecting a reduction in the growth of potential output, arising from factors such as slower growth in the Japanese labour force...