When the Country Isn’t Hiring
It’s important to remember that all the financial aspects of the country are tied together, including the stock market, lending market, housing market and the economy. When one is under pressure, the others feel the squeeze as well. The GDP gap is one way that economists evaluate the damage that is done when the economy can’t provide enough jobs for all the people that want to be employed.
You might be thinking that you don’t need macroeconomic theory to tell you that not being able to put people to work is bad for the economy, but the GDP gap is a tool that helps economists to establish this sentiment in a statistical manner. Simply put, this gap helps to express the output profits that are forfeited when a country’s economy fails to create sufficient jobs for all those have the wiliness and ability to work. The GDP gap represents wasted output potential, because something is limiting the opportunities for work.
What it is:
GDP gap refers to the disparity between an economy’s actual total output and its possible total output.
How it works (Example):
A country’s GDP gap is mathematically expressed in the following way and serves as an indicator of where an economy stands in the business cycle: Gap GDP = GDP Actual – GDP Potential
Measured as an indication of the number of jobs in an economy (labor productivity) a positive gap value indicates an expansion. This means there is still room for the economy to expand, because demand is growing faster than supply and the economy is overproducing with its current resources. This means full employment is exceeded and there is a demand for more workers. Conversely, a negative gap value indicates that an economy is under producing with its current resources, and the economy is not at full employment. Therefore, there are recessionary pressures. A gap value of zero indicates that an economy is operating at its full capacity and at its most efficient point.
To illustrate, suppose a country’s actual GDP is $1 billion and that its potential GDP is $850 million. The gap of $150 million indicates that the country is likely in a period of expansion and probably has a shortage of workers.
Why it Matters:
The GDP gap indicates how efficiently a country is using its productive resources (i.e. aggregate capital assets, raw materials, capital funds, etc.). It also reflects, in terms of expansion, the amount of productive opportunity lost due to employment deficits.
In general central banks and governments try to keep the GDP gap as small as possible, because both positive and negative values indicate inefficiency. Both monetary policy and fiscal policy are used to moderate consumption and investment levels. In macroeconomic theory, positive GDP gaps can indicate inflation and negative gaps can indicate recessions.