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Output gaps
Edexcel IAL Economics · WEC12 Macroeconomic performance and policy
An output gap is the difference between actual output and the economy's potential output. Its sign tells policymakers whether the economy is overheating or has spare capacity.
Trend growth and output gaps
The long-term trend rate of growth is the average rate at which potential output grows over a number of years. Actual growth fluctuates around this trend over the economic cycle (boom, slowdown, recession, recovery).
Output gap (% of potential) = (actual output - potential output) / potential output x 100.
Positive and negative gaps
- Negative output gap: actual output is below potential. There is spare capacity: unemployment is relatively high, inflationary pressure is low, firms have unused capacity, and the budget deficit tends to widen.
- Positive output gap: actual output exceeds potential. The economy is overheating: labour shortages, rising wages, inflationary pressure, firms working beyond normal capacity, and imports rising.
Diagram in words: on a graph of real GDP against time, a smooth upward trend line shows potential; the actual GDP line wavers around it. Where actual is under the trend line, the gap is negative; where it is over the line, positive. On a PPF, a negative gap is a point inside the frontier.
Difficulties of measurement
Potential output cannot be observed directly; it has to be estimated from trends in productivity and the labour force. Data are revised, so the gap is uncertain in real time. Estimates differ between organisations, and a structural change (such as a pandemic or an energy shock) can change potential output itself. So policy based on output gap estimates can be wrong.
Worked example
Actual output is $1940 bn and potential output is $2000 bn. Find the output gap.
- Gap = (1940 - 2000) / 2000 x 100 = -3%
Answer: A negative output gap of -3% of potential: spare capacity.
Check yourself
- Actual GDP is $515 bn and potential GDP is $500 bn. Find the output gap as a % of potential.
Show answer
3 %. (515 - 500) / 500 x 100 = +3%, a positive gap.
- Actual GDP is $1,176 bn and potential GDP is $1,200 bn. Find the output gap as a % of potential (negative for a negative gap).
Show answer
-2 %. (1,176 - 1,200) / 1,200 x 100 = -2%.
- Potential output grows at a trend rate of 2.5% a year from $800 bn. Find potential output after one year in $ bn.
Show answer
$820 bn. 800 x 1.025 = $820 bn.
- Which is a characteristic of a negative output gap?
- Labour shortages and rising wages
- Relatively high unemployment and low inflationary pressure
- Firms working beyond normal capacity
- Rapidly rising inflation
Show answer
Relatively high unemployment and low inflationary pressure. Spare capacity means idle labour and little pressure on prices.
- A positive output gap is most likely to lead to
- falling inflation
- rising unemployment
- a widening budget deficit
- rising inflation
Show answer
rising inflation. Demand exceeds sustainable capacity, so prices and wages rise.
- Why are output gaps difficult to measure?
- Actual GDP is never measured
- Potential output cannot be observed and must be estimated
- Inflation data are not published
- The gap is always zero
Show answer
Potential output cannot be observed and must be estimated. Potential output is an estimate based on assumptions.
- On a PPF diagram, a negative output gap is shown by
- a point on the frontier
- an inward shift of the frontier
- a point outside the frontier
- a point inside the frontier
Show answer
a point inside the frontier. Output is below what the economy could produce.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.