Cambridge International as and a level Economics Ebook

Potential economic growth: 
an increase in the productive 
capacity of the economy.
KEY TERM
220
Cambridge International A Level Economics

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Output gaps and the trade cycle
Th
e diff erence between actual and potential output is 
known as the 
output gap
. 
Figure 9.2 
shows a 
negative 
output gap
. In this situation, there is a lack of aggregate 
demand and there is unemployment of resources.
Output gap: 
a gap between actual and potential output.
Negative output gap: 
a situation where actual output is 
below potential output.
KEY TERMS
It is also possible that an economy may experience a 
positive 
output gap
. Th
is occurs when an economy is producing 
more than its maximum potential as shown in 
Figure 9.5
. 
Output may be beyond maximum potential for a while 
because, in response to high aggregate demand, machinery 
may be worked fl at out and workers may be persuaded 
to work long hours of overtime. However, this cannot be 
sustained since a time will come when machines have to be 
serviced or repaired and when workers will want to reduce 
the number of hours of overtime they work.
Output gaps arise during the course of a trade cycle. 
A 
trade cycle
, which can also be called an economic or 
business cycle, involves fl uctuations in economic activity. 
SELF-ASSESSMENT TASK 
9.1
Slowdown in Latin America’s economies
The economies of Latin America grew by an annual 
average of 4.5% between 2004 and 2012. In 2013 the 
growth rate fell to 2.6%. Of course, the economic growth 
rate varied between the economies of the diff erent 
countries. Brazil’s growth rate was 2.3%, while Peru’s 
was 5%. Unemployment also varied between the 
economies with, for instance, Brazil’s unemployment 
rate being 5% and Peru’s being 6.5%.
Potential economic growth also experienced a decline. 
Two of the key influences on the growth in potential 
output are increased investment and increased 
productivity. Investment in the region did increase in 
2013. On average, investment accounted for 25% of 
GDP but it was only 18% in Brazil. Productivity also 
increased but only by a small percentage. Indeed, 
productivity actually fell in Mexico. There were thought 
to be four major reasons for the low average growth 
in productivity in Latin America. These were relatively 
poor education performance, a lack of innovation, poor 
transport infrastructure and a lack of competition,