Output gap

An output gap measures how far an economy is operating from its full-employment potential. Potential output is the level of real GDP an economy can sustain when labor and capital are fully employed at the natural rate of unemployment. When actual real GDP differs from that benchmark, an output gap exists.

A recessionary gap (negative output gap) occurs when actual output falls short of potential — factories sit idle, unemployment rises above its natural rate, and the economy produces inside its capacity. An inflationary gap (positive output gap) occurs when actual output exceeds potential — resources are stretched beyond sustainable levels, unemployment dips below the natural rate, and upward pressure builds on wages and prices.

In the aggregate demand–aggregate supply model, output gaps close in one of two ways. Left alone, the economy self-adjusts: in a recessionary gap, weak labor demand eventually pushes nominal wages down, shifting short-run aggregate supply rightward until output returns to potential; in an inflationary gap, rising wages shift short-run aggregate supply leftward. Alternatively, policymakers can intervene — expansionary fiscal or monetary policy to close a recessionary gap, contractionary policy to close an inflationary one.

The AP Macroeconomics exam tests output gaps heavily, both in multiple choice and in the free-response graphing questions. Be ready to draw an economy in a recessionary or inflationary gap, label actual and potential output, and show how self-adjustment or a specific policy action returns the economy to long-run equilibrium.