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3)Briefly explain what is meant by the GDP gap.

3)Briefly explain what is meant by the GDP gap.

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GDP Gap (or Output gap) is the difference between (actual) Real GDP and potential GDP. When aggregate demand is lower than the full-employment level, real GDP is lower than potential GDP and a recessionary (negative output) gap arises. On the other hand, when aggregate demand is higher than the full-employment level, real GDP is higher than potential GDP and an inflationary (positive output) gap arises. A recessionary gap is associated with deflation (fall in aggregate price level), while an inflationary gap is associated with inflation (rise in aggregate price level).

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