Recessionary Gap vs Inflationary Gap
Recessionary Gap and Inflationary Gap are two The Business Cycle concepts in AP Economics that students often mix up. A recessionary gap is the difference between full-employment real GDP and actual real GDP when actual is less than full employment. An inflationary gap is the difference between actual real GDP and full-employment real GDP when actual exceeds full employment. Here is how they compare side by side.
A recessionary gap occurs when an economy is producing less than its potential, leading to higher unemployment. This typically happens during a contraction in the business cycle. The gap represents the amount by which real GDP falls short of potential GDP.
An inflationary gap occurs when an economy is producing more than its potential, leading to upward pressure on prices. This typically happens during an expansion in the business cycle. The gap represents the amount by which real GDP exceeds potential GDP.
Recessionary vs Inflationary Gap: Where Output Sits Relative to Potential
| Recessionary gap | Inflationary gap | |
|---|---|---|
| Output relative to potential | Below full-employment output | Above full-employment output |
| Unemployment relative to natural rate | Above it | Below it |
| Pressure on the price level | Downward | Upward |
| Appropriate discretionary policy | Expansionary fiscal or monetary policy | Contractionary fiscal or monetary policy |
| Self-correction mechanism | Wages and input prices fall, SRAS shifts right | Wages and input prices rise, SRAS shifts left |
| Where equilibrium sits on the graph | Left of the long-run aggregate supply curve | Right of the long-run aggregate supply curve |
The gap is a horizontal distance, not a vertical one
Both gaps are measured along the output axis: the horizontal distance between current equilibrium real GDP and full-employment output, which is where the long-run aggregate supply curve stands. If short-run equilibrium sits to the left of long-run aggregate supply, output is below potential and you have a recessionary gap. To the right, output is above potential and you have an inflationary gap. Students often try to measure the gap vertically, along the price level axis, and end up describing an inflation rate instead of a gap. When a rubric row says to identify the gap on the diagram, draw a clearly marked horizontal segment between the two output levels and label it. Set it up yourself at /sandbox/adas.
An inflationary gap is not a contradiction
Output above potential sounds impossible, and students often assume it means the economy cannot produce that much. Full-employment output is not a physical ceiling. It is the sustainable level, the amount produced when unemployment sits at its natural rate. An economy can exceed it temporarily by running factories on overtime, drawing in workers who would normally be between jobs, and deferring maintenance. That is why unemployment sits below the natural rate during an inflationary gap. It is not sustainable, because the tight labour market bids wages up, which raises production costs, which shifts short-run aggregate supply left until output falls back to potential at a higher price level.
Self-correction versus policy, and why the difference matters
Both gaps close on their own eventually. In a recessionary gap, high unemployment eventually pushes wages down, short-run aggregate supply shifts right, and output returns to potential at a lower price level. In an inflationary gap the mechanism runs the other way. The disagreement in macroeconomics is about how long that takes. The Keynesian view is that wages are sticky downward, so a recessionary gap can persist for years and discretionary policy is warranted. The classical view is that markets clear quickly and intervention mostly moves the price level. Exam questions frequently ask you to describe both the self-correction path and the policy path for the same gap, so know each as a separate sequence rather than blending them.
Frequently asked questions
What is a recessionary gap?
A recessionary gap exists when short-run equilibrium real GDP is below full-employment output, so the economy is producing less than its sustainable potential and unemployment is above the natural rate. On the AD-AS diagram it is the horizontal distance from current equilibrium output to the long-run aggregate supply curve, with equilibrium sitting to the left of it.
How do you fix an inflationary gap?
With contractionary policy: reduce government spending or raise taxes, or have the Fed sell bonds, raise the discount rate, or otherwise reduce the money supply. Each shifts aggregate demand left, lowering the price level and returning output to potential. Left alone the gap also closes on its own as rising wages shift short-run aggregate supply left.
Can output really be above full employment?
Yes, temporarily. Full-employment output is the sustainable level, not a physical maximum. Firms can run overtime and draw in workers who would normally be between jobs, pushing unemployment below its natural rate. It cannot last, because the tight labour market raises wages and costs, shifting short-run aggregate supply left.
Live AD/AS Model graph. Drag the curves, or open the full version.
Related comparisons
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated