Tag: labour markets

The output gap is defined as ‘the difference between actual and potential output.’ When actual output exceeds potential output, the gap is positive. When actual output is less than potential output, the gap is negative. The size of the output gap traces the course of the business cycle. In the current recession, the output gap is negative in all major economies. The worry in recent months has been that a persistent large negative gap could lead to a downward deflationary spiral. Evidence is emerging, however, that the recession may be bottoming out and the danger of deflation easing. But just how big is the current negative output gap? As the article below from The Economist states, “Estimating how big the output gap is, and how much of a deflationary threat it still poses, is not easy.”

So how is the output gap measured in practice? How do we measure ‘potential output’? The two articles consider this issue of measurement and the relationship between the output gap and the rate of inflation. The last two links are to data sources giving estimates of the output gap. The first is from the European Commission and the second is from the OECD. As you will see, there are differences in their estimates.

Put out: Uncertainty over the size of the output gap complicates the task of central banks The Economist (2/7/09)
How big is the output gap? FRBSF Economic Letter (12/6/09)

See also:
Box 1.3.2 on page 31 and Table 13 on page 140 of European Economy: Economic Forecast, Spring 2009 European Commission, Economic and Financial Affairs (From the above link, click on the little ‘en’ symbol.)

and: Table 10 from OECD Economic Outlook No. 85, June 2009 OECD (From the above link, click on ‘Demand and output’. The first 10 tables then download as an Excel file.)


  1. Why is it difficult to measure potential output? (See both The Economist article and Box 1.3.2 from the European Economy: Economic Forecast, Spring 2009.)
  2. What is meant by the ‘NAIRU’? Why may it have risen during the recession? How would you set about estimating the value of the NAIRU?
  3. How might you infer the size of the output gap from the behaviour of inflation?
  4. Plot the output gap for two countries of your choice using data from both the European Economy and the OECD Economic Outlook for the years 2004 to 2010. Discuss the differences between (a) the two plots for each country and (b) the two countries.

The article linked to below from Evan Davis’s blog starts with the following multiple choice question:

“What effect do you think it has, if a British bus company employs a bus driver from overseas?

a) it takes away the job of a British bus driver?
b) it increases the number of bus drivers we have?
c) it undercuts the wages of British bus drivers?
d) it reduces bus fares for British passengers?”

What is your answer?

On the buses BBC News Online (5/11/07)


1. Explain what is meant by the phrase “lump of labour fallacy”.
2. Assess the extent to which the most appropriate answer to the multiple choice question is “(e) all of the above”.
3. Discuss the extent to which the answer to the above multiple choice question may differ in a perfectly competitive and imperfect labour market.

The rapid growth in the use of overseas and agency staff for many lower paid jobs has been a contentious issue for many in the trade union movement. Unions have demanded the same rights for agency staff as for permanent staff, but the government is reluctant to do this, arguing that the use of agency staff encourages flexibility in the workforce.

Underpaid, easy to sack: UK’s second class workforce Guardian (24/9/07)


1. Explain the impact that the use of agency staff has on the supply curve for labour. (N.B. You should consider both the position and shape of the curve in your answer.)
2. Discuss the government’s view that “the flexibility provided by agency workers has been a vital part of Britain’s economic success“.
3. Discuss the impact on the UK labour market of giving agency staff the same employment rights as permanent staff.

The national minimum wage will rise again in October 2007 by about 3% from £5.35 to £5.52. However, the Work Foundation has warned that the effectiveness of the minimum wage may be at its limits and that further rises in its level may not have the desired impact in terms of addressing inequality. The articles and press release below consider these issues.

Minimum wage up to £5.52 per year BBC News Online (7/3/07)
National minimum wage at the limits of its effectiveness The Work Foundation – press release (6/3/07)
Warning over minimum wage level BBC News Online (6/3/07)


1. Using diagrams as appropriate, illustrate the likely impact on the UK labour market of the proposed increase in the national minimum wage from October 2007.
2. Assess the arguments given by the Work Foundation that the minimum wage is reaching the limits of its effectiveness.
3. Evaluate two methods other than a national minimum wage for reducing levels of both relative and absolute poverty.

As part of its Target 2.0 competition for students, The Times published a series of briefings looking at the factors that cause inflation. The one linked below considers the role of labour markets in determining inflation.

Interplay of work and inflation rate Times Online (2/2/07)


1. Explain the key determinants of the equilibrium level of wages in the labour market.
2. Assess the role of equilibrium labour market wages in the determination of the level of inflation.
3. Discuss the extent to which the NAIRU is still a relevant theory when considering the determinants of inflation.