Gross domestic product gap measures the difference in real GDP and potential GDP. Real GDP is the measure of a country’s total output at a specified time that fluctuates with business cycles. Potential GDP is the maximum output a country can achieve while maintaining a reasonable price stability.
GDP gap shows how efficiently a country is utilizing its productive resources, such as capital, raw materials and labor. It also indicates the amount of output lost due to a country’s failure to utilize all the available labor. During recessions, the level of unemployment increases, and the GDP gap becomes bigger. There is loss of output because the economy does not utilize the available labor.
GDP indicates the labor productivity in an economy. A positive GDP gap shows that there is room for the economy to expand because the economy is overproducing with its available resources and demand is higher than supply. A negative GDP gap indicates that the economy is not at full employment and is under-producing with its current resources.
A gap value of zero shows that an economy is operating at its efficient point and maximum capacity. Therefore, governments and central banks strive to maintain a small GDP gap since both negative and positive GDP gap values show inefficiency.