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From Investopedia, "A positive output gap indicates a high demand for goods and services in an economy, which might be considered beneficial for an economy. However, the effect of excessively high demand is that businesses and employees must work beyond their maximum efficiency level to meet the level of demand."

And from Lumen: "when the economy is above full employment, then the unemployment rate is less than the natural unemployment rate and real GDP is greater than potential. Operating above potential is only possible for a short while, since it is analogous to workers working overtime."

Why do these websites claim that a positive output gap is not necessarily good? The unemployment rate is less than the natural unemployment rate (full employment rate) if the cyclical unemployment is lower, which means the economy is in an expansion. This means that more people have jobs, not the same workers are working more hours like these sites say, right? I understand that expansions are temporary, and there isn't always going to more output than expected, but why is having real GDP > potential GDP bad?

From what I know, potential GDP is the amount of output of an economy when everyone who should have a job has a job. During an expansion, people who normally couldn't get a job, has jobs because there are more jobs. This increases output. And so Real GDP > Potential GDP. That's it. I don't know why there would be a higher demand for goods, I don't get why workers would need to work overtime.

Can someone please clarify? Thanks!

Links:

https://www.investopedia.com/terms/o/outputgap.asp#:~:text=An%20output%20gap%20indicates%20the,be%20either%20positive%20or%20negative

https://courses.lumenlearning.com/wm-macroeconomics/chapter/natural-unemployment/#:~:text=The%20economy%20is%20considered%20to,equal%20to%20the%20natural%20rate.&text=By%20contrast%2C%20when%20the%20economy,GDP%20is%20less%20than%20potential

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A fisherman usually works 50 hours and catches 50 kg of fish every week. So let's say that his potential (or "natural") output is 50 kg of fish.

Now suppose his boss orders him to work 80 hours per week and catch 80 kg of fish. This 80 kg of fish is his real output and exceeds his potential output of 50 kg. This is not necessarily a good thing and is probably not sustainable:

  • He may prefer to work less (have more leisure rather than the consumption goods that his additional work can buy).
  • He and his fishing rod may be overworked and thus wear out more quickly.

A definition of potential GDP:

Potential gross domestic product (GDP) is a theoretical concept that means different things to different people. To some, it reflects a world in which every worker is matched with the perfect job, every good idea is implemented, and the bad ones are ignored. In this world, resources are allocated optimally with no distortions from the tax code, information frictions, or suboptimal government policies.†

I would add also that potential GDP at any moment is that which can be sustained over the long term, holding constant resources and technology at that given moment.


†This idealized definition isn't actually used to get estimates of potential GDP. Instead, such estimates are simply obtained by smoothing out GDP fluctuations.

If this idealized definition were actually used, then it would in practice be quite impossible for real/actual GDP to ever exceed potential GDP.

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  • $\begingroup$ +1 And if the fisherman works from a boat, routine maintenance of the boat may be neglected, and his tiredness may increase the risk of an accident at sea. $\endgroup$ – Adam Bailey Jul 2 at 11:20
  • $\begingroup$ Also he only catches 65kg of fish in 80 hours because he gets tired. Which is a waste of labour hours. $\endgroup$ – user253751 Jul 2 at 12:05
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I'm not sure that I would trust Investopaedia for economics. Take for example, the following sentence from what you have quoted:

However, the effect of excessively high demand is that businesses and employees must work beyond their maximum efficiency level to meet the level of demand.

There is no 'must' about it. For example, workers may decide that this is the perfect opportunity to organise a strike.

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