Explain what economists mean by a 'deflationary gap' and discuss why this could be considered problematic for an economy. Use a diagram to illustrate your answer.

Mark scheme

Marking points from the official mark scheme (May/June 2018). The mark or mark type is shown in brackets.

1. [12] L4 (9-12): for an answer that extends the range of reasons why a deflationary gap might produce negative outcomes, such as potential long run negative effects on expectations or the existence of a liquidity trap. Responses which attempt to locate possible positive effects, for example lower cost of living, improvement in the balance of payments, should also be rewarded. There should be a conclusion.
2. [12] L3 (7-8): for an answer that makes some attempt to analyse why a deflationary gap is likely to be associated with negative outcomes such as unemployment and/or low growth rates.
3. [12] L2 (5-6): for answer that describes what is meant by a deflationary gap and is supported by a reasonably accurate diagram.
4. [12] L1 (1-4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory.
5. [13] L4 (9-13): for responses that recognise there are problems associated with deficit financing such as crowding out, long term effects on the price level. Higher level four responses will then consider alternative approaches such as supply side policies and/or market liberalisation. A conclusion should be provided.
6. [13] L3 (7-8): for responses that analyse the links between the use of budget deficits and deflationary gaps. Clear diagrams illustrating how deficits can be used to close the gap will be provided. Some attempt should be made to develop answers which recognise that budget deficits alone are unlikely to solve problems associated with negative expectations.
7. [13] L2 (5-6): for an understanding of the term budget deficit and how this might provide a solution to the problem of a deflationary gap. Answers will be descriptive and not go beyond linking the policy to key issues of unemployment and low growth rates.
8. [13] L1 (1-4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory.