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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

An economy has potential output of ₹500 thousand crore and actual output of ₹520 thousand crore. Which of the following is the most consistent conclusion for firms operating in that economy?

There is a positive output gap of 4% of potential output, since 20 divided by 500 is 4%. Demand exceeds sustainable capacity, so unemployment is below its natural rate and wages and prices tend to rise, creating inflationary pressure.

  1. AThere is a negative output gap and deflationary pressure is likely
  2. BThere is a positive output gap of 4% of potential and upward pressure on wages and prices is likelyCorrect
  3. CThere is a positive output gap of 4% of actual output and unemployment is above its natural rate
  4. DThe output gap is zero because actual output exceeds potential
  5. There is a negative output gap of 4% and unemployment is rising

Explanation

Output gap = (520-500)/500 = 4% of potential, positive. Actual output above potential means resources are overused, unemployment below the natural rate, and wage and price pressure. Measuring against actual output would give 3.85%, and a negative gap would require actual below potential.

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