In the diagram line OY shows the different level income in the economy it is a 45° line because national income can be calculated through product approach or through income approach and it will give a same financial figure line C + I shows the aggregated demand of the economy at point A this line is intersecting income line so it shows the equilibrium in the econo­my which also happens to be at full employment OYf. In the General Theory, he started with underemployment equilibrium. Excess demand or inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. 12. It occurs when the real output of an economy is above the potential output of the economy. The larger the aggregate expenditure, the larger the gap and the more rapid the inflation. Thus Rs. This situation is considered an inflationary gap—the difference between aggregate demand beyond full employment and aggregate demand at full employment. 200 crores. An inflationary … The entire NCERT textbook questions have been solved by best teachers for you. Panel (a) shows that if employment is above the natural level, then output must be above potential. A deflationary gap is a situation where the saving exceeds the existing level of investment so in the later case a reduction in the rate of interest will increase the investment and through multiplier it will increase in the income. One final note: recessionary and inflationary gaps are related to the empirical concept of the GDP gap we defined earlier in this module. But the output cannot be increased because all resources are fully employed in the economy. It may be defined as the excess of planned levels of expenditure over the available output at base prices. This inflationary gap model is illustrated as under: In reality, the enitre disposable income of Rs. Syllabus: Discuss why, in contrast to the monetarist/new classical model, the economy can remain stuck in a deflationary (recessionary) gap in the Keynesian model. If the economy is facing the deflationary gap then it is the first objective of the fiscal or monetary agent the government to increase the level of income to full employment. Inflationary Gap. This leads to inflation. Share Your PDF File Deflationary gap is mea­sured by the excess of saving over investment or by the difference of income levels at equilibrium and at full employment. Inflationary Gap: Inflationary gap is the amount by which the actual aggregate demand exceeds ‘aggregate supply at level of full employment’. Potential (light) and actual (bold) GDP estimates from the Congressional Budget Office. 152 crores (Rs. This inflation gap is measured as the excess of aggregate expenditure over full employment aggregate supply ( Y > Yfe ). This is AB in the figure. A growing economy or increase in the supply of money – When consumers feel confident, they spend more and take on more debt. Distinguish between the following, Long-run full employment, short-run recessionary gap, short-run inflationary gap, and short-run stagflation. The inflationary gap is shown diagrammatically in Figure 5 where OYF is the foil employment level of income, 45° ine represents aggregate supply AS and C + 1 + G line the desired level of consumption, invest­ment and government expenditure (or aggregate demand curve). 8.16, BE is shown as inflationary gap. Causes of Inflationary Gap (i) Increase in private consumption expenditure (C). As there is already foil employment, the increase in money wages leads to proportionate rise in prices. He defined an inflationary gap as an excess of planned expenditure over the available output at pre-inflation or base prices. 3,000 FRM Practice Questions – QBank, Mock Exams, and Study Notes. If, say 20 per cent (Rs. FRM Study Platform. What is the definition of inflationary gap? According to Lipsey, “The inflation­ary gap is the amount by which aggregate expenditure would exceed aggregate output at the full em­ployment level of income.” Suppose the government taxes away Rs. Excess Demand and Deficient Demand – CBSE Notes for Class 12 Macro Economics. In his pamphlet ‘How to pay for the War’ published in 1940, Keynes explained the concept of the inflationary gap. 152-120) crores instead of Rs. This type of inflation is caused due to an increase in aggregate demand in the economy. If the aggregate demand is such that the level of income as OYi or point B which is above the full employment level then the distance AB shows the inflationary pressure in the economy and if the actual level income is OYd is below the full employment level. Another way the government is able to increase the level of income is by its expenditure government under this situation can inject money in the economy by taking up certain public and social projects like making of A dams it will augment the income level of the economy. Notes Quiz. So the inflationary gap can be closed by increasing taxes and reducing expenditure. An economic boom may be the result of an increase in AD. 120 crores. In general, profit is a rising function of the price level. Inflationary gap occurs when aggregate demand (AD) exceeds aggregate supply (AS) at full employment level of output. As a policy measure, it suggests reduction in aggregate demand to control inflation. In the case of an inflationary gap, the real GDP is higher than the potential GDP. An inflationary gap exists when the demand for goods and services exceeds production due to factors such as higher levels of overall employment, … An inflationary gap rises when saving falls short of the total investment of the economy or the excess of equilibrium level of income over the full employment level of income, after full employment is reached the physical output cannot be increased so whatever may be the increase in income it is an increase in the financial value of the existing products. The inflationary gap is equal to the difference between the level of the aggregate demand at full employment level and actual aggregate demand, that is, the gap between actual aggregate demand and planned aggregate demand which is required to establish full employment equilibrium. In other words, the inflationary gap refers to the difference (that is, the gap) between the actual gross domestic product (GDP) and the GDP that would exist if the economy were at full employment (this is also known as the “potential GDP”). We can see from the GDP equation that if consumption, investment, government spending, or net exports increases, there will be excess demand. TOS4. “The analysis of the inflationary gap in terms of such aggregates as national income, investment outlays and consumption expenditures clearly reveals what determines public policy with respect to taxes, public expenditures, savings campaigns, credit control, wage adjustment—in short, all the conceivable anti-inflationary measures affecting the propensities to consume, to save and to invest which together determine the general price level.”, Economics, Notes, Inflation, Inflationary Gap. (This is in contrast to a deflationary gap, … Keynes, on the other hand, ascribed it to the excess of expenditure over income at the full employment level. Despite these criticisms the concept of inflationary gap has proved to be of much importance in explaining rising prices at foil employment level and policy measures in controlling inflation. A recessionary gap is an economic state where the real GDP is out-weighted by the potential GDP under full employment. Content Guidelines 2. Inflationary gap. The amount by which real GDP exceeds potential GDP is called an inflationary gap. 70 crores. Moreover, output cannot be increased during the short run because factors are already folly employed. The amount by which aggregate demand (YFA) exceeds the aggre­gate supply (YFB) at the foil employment income level is the inflationary gap. Free PDF Download - Best collection of CBSE topper Notes, Important Questions, Sample papers and NCERT Solutions for CBSE Class 12 Economics Excess Demand And Deficient Demand. Inflationary gap is when the Aggregate demand exceeds the productive potential of the economy. It also favours saving incentives to reduce consumption expenditure. Starting at long-run equilibrium, an increase in aggregate demand shifts the AD curve rightward. Share Your PPT File. He defined an inflationary gap as an excess of planned expenditure over the available output at pre-inflation or base prices. 190 crores as disposable income. (ii) Credit inflation: ... To meet this gap, the government may ask the central bank to print additional money. It leads to the reduction in inventories and inflation in the economy. Inflationary and deflationary gaps As we saw earlier, Keynesian analysis of the economy assumes that the economy can settle at any equilibrium. In the above diagram full employment level of income is M = 2200 million at income level N = 1400 million there is equilibrium but this is not at all employment or C + I is less than C + S as it is compared at equilibrium, so expenditure must increase by 800 to reach full employment level of income if the value of the multiplier is four their just an increase of 200 million in invest­ment expenditure should be suffice to reach the full employment level and bridge the deflationary gap. Inflationary gap thus describes disequilibrium situation. 190 crores is the amount to be spent on the available output worth Rs. Demand-Pull Inflation. For instance, in Fig. 70 crores. CBSE Notes CBSE Notes Macro Economics NCERT Solutions Macro Economics Introduction An illustration of meaning, diagram, reasons, impacts and measures to control excess demand (inflationary gap) and deficient demand (deflationary gap); basic definitions of full employment, over full employment, … Otherwise known as an expansionary gap, an inflationary gap is the gap between an economy’s full-employment real GDP and its real GDP. 3000 million of N, there is an excess of Rs. Disclaimer Copyright, Share Your Knowledge But there being foil em­ployment at the current money wage, they offer higher money wages to induce more workers to work for them. Prices continue to rise so long as this gap persists. But this may lead to deflationary tendencies. Share Your Word File It is created due to the effective demand being in excess of the full employment level. It is one type of output gap, the other being a recessionary gap. Privacy Policy3. Explain the meaning of inflationary gap and deflationary gap. Inflation. An example will help us to clear the meaning of the concept of inflationary gap. The inflationary gap, shown in Panel (b), equals Y 1 − Y P. The aggregate demand curve AD and the short-run aggregate supply curve SRAS intersect to the right of the long-run aggregate supply curve LRAS. The economy’s aggregate demand curve (C + l + G) = AD intersects the 45° line (AS ) at point E at the income level OF, which is greater than the full employment income level OYF. Inflationary gap Meaning: When in an economy, aggregate demand is in excess of ‘aggregate supply at full employment’, the demand is called an excess demand. Excess demand occurs in a situation when aggregate demand is more than aggregate supply corresponding to full employment. It tells that the rise in prices, once the level of foil employment is attained, is due to excess demand generated by increased expenditures. 80 crores is spent by the government. This type of infla­tion is caused by the printing of cur­rency notes. An inflationary gap is always related to a business-cycle expansion and arises when the equilibrium levelof an economy’s aggregate output is greater than the output that could be produced at full employment. Also Read:     Detailed Note on Inflation            What is Stagflation       Indifference Curve Analysis. A recessionary gap corresponds to a positive GDP gap where actual GDP is less than potential, while an inflationary gap corresponds to a negative GDP gap where actual GDP is greater than potential. Under these circumstances an agency is required to stabilize the economy’s income level at or near full employment level. The distance between Y2 and Y1 is the inflationary gap that opened. The inflationary gap can be wiped out by increase in savings so that the aggregate demand is reduced. An inflationary gap rises when saving falls short of the total investment of the economy or the excess of equilibrium level of income over the full employment level of income, after full employment is reached the physical output cannot be increased so whatever may be the increase in income it is an increase in the financial value of the existing products. ... inflation has a favourable effect on production. AnalystPrep’s Video Series – Level I of the CFA® Exam. 800 million over full employment so now there must be contraction in the level of income and again the multiplier is four a fall of 200 million in the expenditure would be sufficient to regain the full employment level of income, a deflationary gap represents a deficiency of expenditure and an inflationary gap represents a deficiency of expenditure and an inflationary gap shows an excess of expenditure over full employment level of income. To fight this gap, gover… But the gross national income at current prices at full employ­ment level is Rs. But Keynes was not in favour of monetary measures to control inflationary pressures within the economy. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Under monetary policy government can do it either by increasing money supply or by reducing the rate of interest in the former case the expenditure and ultimately the aggregate demand of the economy. Of this Rs. 190 crores is not spent and a part of it is saved. Basically , the inflationary gap occur because of the continuous increase in price level. Inflationary Gap The excess of Aggregate Demand above the level that is required to maintain full employment level of equilibrium is termed as inflationary gap. In other words, when AD > AS it causes rise in prices and hence, leads to inflationary gap. 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