Gdp Gap

Published Oct 25, 2023

Definition of GDP Gap

The GDP gap refers to the difference between the actual level of GDP and the potential level of GDP. It measures the difference between what the economy is actually producing and what it could potentially produce at full employment. The GDP gap can be positive, indicating an output level below potential, or negative, indicating an output level above potential.

Example

Let’s say the potential level of GDP for a country is $1 trillion. However, due to a recession, the actual level of GDP is only $900 billion. In this case, the GDP gap would be $100 billion ($1 trillion – $900 billion), indicating a negative gap.

Conversely, if the actual level of GDP exceeds the potential level, the GDP gap would be positive. For example, if the actual level of GDP is $1.1 trillion, the GDP gap would be $100 billion ($1.1 trillion – $1 trillion), indicating an output level above potential.

Why GDP Gap Matters

The GDP gap is an important economic indicator as it provides insights into the health and performance of an economy. A positive GDP gap suggests that the economy is operating above its potential, which could lead to inflationary pressures. On the other hand, a negative GDP gap indicates a recessionary gap, signaling an underutilization of resources and potential loss of output.

Policy-makers and economists closely monitor the GDP gap to assess the state of the economy and make informed decisions. It helps guide fiscal and monetary policies aimed at stabilizing the economy and closing the gap between actual and potential GDP through measures such as stimulating economic growth or implementing contractionary policies to curb inflation.