What does a recessionary gap in the AD-AS model signify?

A recessionary gap in the Aggregate Demand-Aggregate Supply (AD-AS) model highlights a situation where the actual output of an economy is below its potential output. This indicates that the economy is not operating at full capacity, resulting in underutilization of resources such as labor and capital. When actual output falls short of potential output, it signals a lack of demand for goods and services, which can lead to higher unemployment rates and decreased overall economic activity.

This condition arises typically during economic downturns, where consumer and business spending declines, causing firms to reduce production and consequently lay off workers. By recognizing the presence of a recessionary gap, policymakers can implement strategies aimed at stimulating economic activity, such as increasing government spending or lowering interest rates to encourage borrowing and investment.