An output gap is the difference between the actual production level of a business and the amount of output that the business could achieve if it were operating at full capacity. The term is also applied to a national economy as well as to businesses, with a national output gap being related to the actual output in comparison to the output that the nation would experience if all its resources were used in the most efficient manner. For example, if a nation is undergoing a period during which a large section of the workforce is idle, this means that the output gap is likely to be wider, since valuable resources are not being used.
As it relates to nations, determining the output gap often involves considering the current level of the gross domestic product, or GDP. This simply refers to the output of the country over a specified period of time, based on all relevant factors. That figure is compared to what is known as the potential GDP, which is the amount of output that the nation would experience during that same period if resources were used more efficiently. In the best of situations, this output gap is relatively small, indicating that resources are being used at or at least close to maximum efficiency, and the resulting return is within the highest range possible.
It is possible to experience a positive or a negative output gap. With a positive gap, there is almost no difference between actual output and the output that would occur if all resources are fully utilized. A negative gap is a situation in which actual output is far less than potential output, allowing for access to the same resources in the same time period. A negative output gap that is exceptionally wide is a sign that there is serious difficulties with the nation’s economy, and that action must quickly take place in order to reverse the situation and avoid an even worse economic crisis from occurring.
In like manner, an output gap within a given business can either be proof that the company is moving in a profitable direction or that there are serious operation issues that must be addressed before the company is undermined and must close. When the actual output is close to capacity, this is a sign that the business is healthy and operating responsibly. Should the actual output be far below its potential, actions to reduce expenses and make better use of resources is essential if the company is to correct the situation and avoid falling into financial ruin.