Output gap is the difference between actual output and the output that could be achieved if operating at full capacity. It applies to national economies and businesses, with a negative gap indicating trouble and actions needed to prevent further economic crisis.
An output gap is the difference between a firm’s actual output level and the amount of output the firm could achieve if it were operating at full capacity. The term also applies to a national economy and businesses, with a national output gap that correlates with actual output compared to the output the nation would experience if all of its resources were used most efficiently. For example, if a nation is experiencing a period in which a large proportion of the workforce is idle, this means that the output gap is likely to be larger, as valuable resources are not being used.
As far as nations are concerned, determining the output gap often involves looking at the current level of gross domestic product, or GDP. This simply refers to the country’s output over a given period of time, based on all relevant factors. That figure is compared to so-called potential GDP, which is the amount of production the nation would experience during that same period if resources were used more efficiently. At best, this output gap is relatively small, indicating that resources are being used at or near maximum efficiency, and the resulting return is in the highest possible range.
A positive or negative output gap may occur. With a positive gap, there is almost no difference between the actual output and the output that would occur if all resources were fully utilized. A negative gap is a situation where actual output is much less than potential output, allowing access to the same resources over the same period of time. A negative output gap that is exceptionally large is a sign that there is serious trouble with the nation’s economy and that action must quickly take place to reverse the situation and prevent an even worse economic crisis from occurring.
Similarly, a production gap within a particular business can be evidence that the company is moving in a profitable direction or that there are serious operational problems that need to be addressed before the company is weakened and needs to fill. When actual output is close to capacity, this is a sign that the business is healthy and operating responsibly. Should actual output fall far short of its potential, actions to reduce expenditure and make better use of resources are essential if the company is to correct the situation and avoid falling into financial ruin.
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