The GDP gap, also known as the output gap, is an economic indicator that measures the difference between actual gross domestic product (GDP) and potential GDP. Potential GDP refers to the level of output an economy can produce when all resources, including labor and capital, are fully employed at their normal levels of utilization. The GDP gap provides insight into the health of an economy and helps assess whether it is operating at its full capacity or is experiencing a recessionary or inflationary gap.

The formula for calculating the GDP gap is:

\[ \text{GDP Gap} = \text{Actual GDP} – \text{Potential GDP} \]

Here’s how the GDP gap is interpreted based on its value:

1. **Positive GDP Gap (Expansionary Gap):** If the GDP gap is positive, it indicates that actual GDP is above potential GDP. This situation suggests that the economy is operating beyond its capacity, and there is upward pressure on prices. It may be a sign of inflationary pressures.

2. **Negative GDP Gap (Recessionary Gap):** If the GDP gap is negative, it suggests that actual GDP is below potential GDP. This situation indicates that the economy is not operating at full capacity, and there may be unused resources, including labor. A negative gap suggests economic slack and the potential for unemployment.

3. **Zero GDP Gap:** A GDP gap of zero implies that actual GDP is equal to potential GDP. In theory, this situation represents an economy operating at its full potential with no inflationary or recessionary pressures.

Governments and central banks use the concept of the GDP gap to formulate economic policies. For example:

– **Expansionary Policies:** In the case of a negative GDP gap (recessionary conditions), policymakers may implement expansionary fiscal or monetary policies to stimulate economic activity and close the gap.

– **Contractionary Policies:** In the case of a positive GDP gap (inflationary pressures), policymakers may implement contractionary policies to cool down the economy and prevent overheating.

Economists and policymakers often rely on estimates and models to determine potential GDP since it is not directly observable. The GDP gap is a useful tool for understanding the cyclical position of an economy and guiding policy decisions to promote economic stability.