Cambridge A Level Economics: Growth, output gaps, the business cycle and policies (9708) – Revision Notes

These notes condense outcomes 9.2.1 to 9.2.4 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topic 9 is A Level content and is not examined at AS. For full explanations read the study guide, then test yourself with the practice questions. All figures are invented for illustration.

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Key definitions (9.2.1 and 9.2.2)

Term	Meaning	Diagram clue
Actual growth	Percentage rise in real GDP	AD shifts right; move towards the PPC
Potential growth	Percentage rise in productive capacity	LRAS shifts right; PPC moves out
Output gap	Actual output minus potential output	Actual real GDP is left or right of the LRAS line
Positive gap	Actual above potential: overheating	Inflation pressure, low unemployment
Negative gap	Actual below potential: spare capacity	Falling inflation, high unemployment

Formulas

Item	Formula
Growth rate	(new − old) / old × 100
Output gap (%)	(actual − potential) / potential × 100
Multiplier	1 / (mps + mpt + mpm), or 1 / (1 − mpc) in a closed economy with no tax
Change in income	multiplier × change in injection
Injection to close a gap	gap in output / multiplier
Potential growth (from inputs)	(1 + labour growth) × (1 + productivity growth) − 1

mps is the marginal propensity to save, mpt the marginal rate of tax and mpm the marginal propensity to import.

Method boxes

Measuring a gap. Step 1: find actual and potential output. Step 2: subtract (actual minus potential). Step 3: divide by potential. Step 4: state positive or negative and what it means for unemployment and inflation.

Does a gap close? Compare actual growth with potential growth. If actual growth is higher, a negative gap narrows or a positive gap widens. If it is lower, the reverse happens.

Identifying a phase. Look at the level of output and its growth rate. Growth falling but positive is a downturn. Falling output is recession. The lowest output is the trough. Rising growth after the trough is recovery. Fast growth with output above trend is a boom.

Worked reminders

Gap narrowing. Country M (invented): actual output rises from 640 to 672 (+5.0%), potential from 700 to 724.5 (+3.5%). Gap before: (640 − 700) / 700 = −8.57%. Gap after: (672 − 724.5) / 724.5 = −7.25%. It narrows but does not close.

Stabiliser strength. A fall in exports of 30 with mps = 0.15, mpm = 0.10 and mpt = 0.25 gives a multiplier of 1 / 0.50 = 2.0 and a fall in income of 60. If mpt were 0.10, the multiplier would be 1 / 0.35 = 2.86 and the fall would be 85.7. A higher marginal tax rate means a smaller swing.

Tax revenue. If income falls by 50 and the marginal tax rate is 0.25, revenue falls by 12.5 without any decision.

Closing a negative gap. Actual 1,045, potential 1,100, multiplier 2.2. Gap = −5.0%. Output must rise by 55, so injection = 55 / 2.2 = 25.

Potential growth from inputs. Labour force +2.0%, output per worker +1.5%: (1.02 × 1.015) − 1 = 3.53%.

Chains of reasoning to learn

Positive output gap. Aggregate demand above sustainable capacity, then firms use overtime and run short of labour, then wages and costs rise, then firms raise prices, then inflation accelerates. Imports are also pulled in as demand outruns domestic supply. The gap cannot last: it closes through higher prices, tighter policy or a downturn.

Negative output gap. Weak demand, then firms cut output and jobs, then unemployment rises and income falls, then spending weakens further through the multiplier. Inflation pressure falls because firms and workers have little pricing power. Lost output is never recovered, and a long gap can cut potential output by reducing investment and skills.

Higher potential growth. More or better factors or technology, then lower costs per unit and more capacity, then LRAS shifts right, then higher output can be sustained with lower inflation pressure.

Stabiliser in a slump. Income falls, then tax revenue falls and benefit payments rise, then disposable income falls by less than income, then consumption is supported and the fall in aggregate demand is smaller.

More worked reminders

Stimulus matched to the gap. Country S (invented): potential output 1,500, multiplier 2.0, extra government spending 40. If actual output is 1,380 (gap −8.0%), the rise is 80, to 1,460, and the gap becomes −2.67%. If actual output is 1,560 (gap +4.0%), the rise gives 1,640 and a gap of +9.33%. The same policy helps in the first case and overheats the economy in the second.

Index numbers across the cycle. Growth of +2%, −1% and −2% from a base of 100 gives 102, 100.98 and 98.96. Output has fallen below the base year, so the economy is in recession. Two further years of +3% give 101.93 and 104.99. Output regains the peak of 102 only in the final year, even though growth was positive in both years.

The business cycle (9.2.3)

Phase	Growth and output	Unemployment	Inflation	Gap
Boom or peak	Fast growth, output high	Low	Rising	Positive
Downturn	Growth slows or turns negative	Starts to rise	Slowing	Narrowing
Recession or trough	Output falls to its lowest	High	Low or falling	Negative
Recovery	Growth returns	Falls	Starts to rise	Closing

Causes to recall (D C A M S P):

• Demand expectations and confidence.
• Credit and interest rates.
• Accelerator effect on investment.
• Multiplier magnifying changes in spending.
• Shocks: external demand, commodity prices, technology, natural events, stock cycles.
• Policy mistakes or time lags.

Automatic stabilisers. Progressive income tax and benefits linked to unemployment change automatically with income. In a boom they raise tax revenue and cut benefit spending, withdrawing demand. In a slump they do the opposite. They reduce the size of the cycle, not remove it. They are not discretionary policy.

Policies to promote growth (9.2.4)

Policy	Targets	Main strength	Main weakness
Higher government spending or lower taxes	Actual growth	Fast; multiplier	Inflation near capacity; deficit; crowding out
Lower interest rates	Actual growth	Quick to implement	Weak if confidence is low; lags
Education, training	Potential growth	Raises productivity	Long lags; costly
Infrastructure	Both	Raises capacity and demand	Costly; poor projects waste money
Tax incentives, R&D support	Potential growth	Raises investment	Uncertain; may favour the rich
Competition, deregulation, trade opening	Potential growth	Lower costs	Job losses; winners and losers

Evaluation prompts. Which gap is the economy in? Is the problem demand or supply? How long will the policy take? What does it cost and who pays? Does it worsen inflation, the budget, the current account or the environment? Is the effect temporary or lasting?

Judging effectiveness: time lag, size and sign of the gap, cost and crowding out, effect on other objectives, short run against long run, how reliable estimates are.

Must-know distinctions

• Actual growth moves AD along SRAS. Potential growth moves LRAS.
• A negative gap does not mean negative growth. Output can grow while the gap stays negative.
• Automatic stabilisers happen without a decision. Discretionary policy needs a decision.
• Recession is a fall in output. A downturn is a slowing of growth.
• Demand-side policy is quicker but temporary. Supply-side policy is slower but raises capacity.

Quick self-test

1. Define potential growth.
2. Actual output is 1,155 and potential output is 1,100. Calculate the output gap.
3. Actual is 1,045 and potential 1,100. The multiplier is 2.2. How big an injection closes the gap?
4. The labour force grows 2.0% and output per worker 1.5%. Calculate potential growth.
5. Why can actual growth exceed potential growth only for a time?
6. Give two automatic stabilisers.
7. Real GDP index 100 rises 3%, falls 1%, then rises 2.5%. What is the final index?
8. mps = 0.1, mpt = 0.3, mpm = 0.1. Investment falls by 15. Calculate the fall in income.
9. Growth was 3.0%, then 1.2%, then 0.4%. Which phase is this?
10. Why is the size of an output gap uncertain?

Answers

1. The percentage increase in the economy’s productive capacity.
2. (1,155 − 1,100) / 1,100 × 100 = +5.0%, a positive gap.
3. Gap in output 55; 55 / 2.2 = 25.
4. 1.02 × 1.015 − 1 = 3.53%.
5. Output cannot stay above capacity: shortages and wage and price pressure build up.
6. Progressive income tax and unemployment benefits.
7. 100 × 1.03 × 0.99 × 1.025 = 104.5.
8. Multiplier = 1 / 0.5 = 2.0; fall = 30.
9. A downturn: growth is positive but slowing.
10. Potential output is estimated, not observed, and is revised.

Where marks are usually lost

• Dividing the gap by actual output instead of potential.
• Treating a positive gap as only good news, with no mention of inflation.
• Confusing the cycle phases: slowdown, recession and trough are not the same.
• Saying stabilisers need a government decision.
• Using a demand-side policy for a supply problem, or the reverse.
• Listing policies with no judgement of timing, cost or side effects.
• Forgetting that stimulus in a positive-gap economy mainly raises prices.
• Not using the figures when the question gives data.

Official syllabus

Cambridge International AS & A Level Economics (9708), syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment (Cambridge International Education), sections 9.2.1 to 9.2.4.