What best defines a Negative Output Gap?

What best defines a Negative Output Gap?

• A. Exists when aggregate output is below potential output; gap to the left of LRAS.
• B. Exists when aggregate output is above potential output; gap to the right of LRAS.
• C. No such gap exists in the economy.
• D. A gap only occurs in long-run equilibrium.

Answer: (B)

A negative output gap occurs when actual aggregate output is below the economy’s potential level, meaning the economy is operating inside its capacity and unemployment is higher than the natural rate. On a diagram with LRAS vertical at potential output, this situation sits to the left of LRAS. The option that describes the gap as above potential and to the right of LRAS would define a positive output gap, not a negative one. Also, gaps can occur in the short run, so the idea that no gap exists is not accurate.

A negative output gap occurs when actual aggregate output is below the economy’s potential level, meaning the economy is operating inside its capacity and unemployment is higher than the natural rate. On a diagram with LRAS vertical at potential output, this situation sits to the left of LRAS. The option that describes the gap as above potential and to the right of LRAS would define a positive output gap, not a negative one. Also, gaps can occur in the short run, so the idea that no gap exists is not accurate.