What Is an Output Gap? Positive and Negative Gaps
What is an output gap? Learn how actual and potential output differ, what positive and negative gaps mean, and how to calculate one with a simple example.
An output gap is the difference between an economy’s actual output and its potential output. Actual output is the goods and services currently produced, measured by real GDP. Potential output is the amount the economy can produce sustainably when its resources are normally employed.
Where it fits: In Cambridge International A Level Economics, positive and negative output gaps are covered in point 9.2.2, Economic growth and sustainability. This builds on AS topic 4, The Macroeconomy.
Positive and negative gaps
A negative output gap means actual output is below potential output. Some productive resources, such as labour and machinery, are underused. Unemployment is likely to be higher than it would be if the economy were producing at potential. The gap can narrow if actual output grows faster than potential output, even if both are increasing.
A positive output gap means actual output is above potential output. This can happen for a time if firms use resources more intensively than normal, for example by asking staff to work overtime. It may increase pressure on wages and prices, but is unlikely to be sustainable indefinitely.
Worked example
Suppose potential real GDP is 200200200 billion units of currency and actual real GDP is 190190190 billion. Using potential output as the base:
Output gap=actual output−potential outputpotential output×100=190−200200×100=−5%.\text{Output gap} = \frac{\text{actual output} - \text{potential output}}{\text{potential output}} \times 100 = \frac{190-200}{200}\times 100 = -5\%.Output gap=potential outputactual output−potential output×100=200190−200×100=−5%.The economy has a negative output gap of 5%5\%5%: it is producing 5%5\%5% less than its estimated sustainable potential. The minus sign matters: it shows actual output is below potential. If actual output exceeded potential instead, the same calculation would give a positive result. Because potential output is an estimate, the calculated gap is an estimate too, not an exact count of unused resources.
Common mistake: Do not confuse a negative output gap with falling output. Output can be growing while still remaining below potential. Equally, a positive gap does not mean the economy can keep producing above potential without pressure on its resources.
