T I S I N F LAT I ON A RY

WHA
GAP?
O NC EP T TH AT M E A SURES THE
A R Y G AP  IS A MA C ROECONOMIC C P RODUCT
AN INFLATION VEL OF REAL GR O SS D O M E S TIC
C U RR E NT L E
DIFFERENCE BETWE
EN T H E
O M Y W A S O P E RA TING AT FULL
OU LD E XIST IF AN ECON
(GDP) AND THE G DP T HA T W EMPLOYMENT.
INTRODUCTION
• INFLATIONARY GAP IS AN OUTPUT GAP, THAT SIGNIFIES THE DIFFERENCE BETWEEN THE ACTUAL GDP
AND THE ANTICIPATED GDP AT AN ASSUMPTION OF FULL EMPLOYMENT IN ANY GIVEN ECONOMY.

• INFLATIONARY GAP = REAL OR ACTUAL GDP – ANTICIPATED GDP

• THERE ARE TWO TYPES OF GDP GAPS OR OUTPUT GAPS. WHILE THE INFLATIONARY GAP IS ONE, THE
RECESSIONARY GAP IS THE OTHER. AN INFLATIONARY GAP CAN BE UNDERSTOOD AS THE MEASURE OF
EXCESS AGGREGATE DEMAND OVER AGGREGATE POTENTIAL DEMAND DURING FULL EMPLOYMENT. A
RECESSIONARY GAP IS AN ECONOMIC STATE WHERE THE REAL GDP IS OUT-WEIGHTED BY THE POTENTIAL
GDP UNDER FULL EMPLOYMENT.

• JOHN MAYNARD KEYNES IS REGARDED TO HAVE BROUGHT THE MODERN DEFINITION OF THE
INFLATIONARY GAP.
EXAMPLE :-
• SAUDI ARABIA EMPLOYS ALL ITS AVAILABLE RESOURCES AND PRODUCES 11.6 BARRELS OF OIL PER
DAY. THE AGGREGATE DEMAND FOR OIL IS ESTIMATED AT 5 BARRELS OF OIL PER DAY BECAUSE
THERE IS A GROWING UNCERTAINTY OVER OIL SUPPLIES, REGIONAL CONFLICT AND PRICE HIKES,
WHICH LOWER CONSUMER CONFIDENCE. IN THIS CASE, SINCE THE AGGREGATE DEMAND (REAL
GDP) IS LOWER THAN THE FULL-EMPLOYMENT REAL GDP, THERE IS NO INFLATIONARY GAP.

• CONVERSELY, IF THE AGGREGATE DEMAND FOR OIL WAS 13.2 BARRELS OF DAY, AND CONSUMER
CONFIDENCE WAS HIGH, THERE WOULD BE AN INFLATIONARY GAP OF 1.6 BARRELS OF OIL PER DAY
BECAUSE THE AGGREGATE DEMAND (REAL GDP) WOULD BE HIGHER THAN THE FULL-EMPLOYMENT
REAL GDP.

• THEREFORE, WHEN THE FULL-EMPLOYMENT REAL GDP IS X, AND THE AGGREGATE DEMAND (REAL
GDP) IS X+1, THERE IS AN INFLATIONARY GAP THAT NEEDS TO BE CORRECTED WITH
CONTRACTIONARY FISCAL POLICY.
For instance, let’s say there is a national economy that is
producing 10,000 gallons of milk per week. However, the
aggregate weekly demand for milk is 15,000 gallons. This means
there is an inflationary gap of 5,000 gallons of milk per week. The
aggregate demand for milk is higher than the full-employment
real GDP. On the other hand, if the aggregate demand for milk
were only 8,000 gallons of milk per week, there would be no
inflationary gap.
ADVANTAGES
• BELOW ARE THE ADVANTAGES OF THE INFLATIONARY GAP.
• IT IS A GOOD MEASURE TO LAYOUT ECONOMIC POLICIES. IT IS ALSO
USEFUL IN THE CRITICAL ANALYSIS OF THESE ECONOMIC POLICIES
(FISCAL AND MONETARY).
• IF THE RESOURCES OF AN ECONOMY ARE FULLY DEPLOYED IN
CONTRIBUTION TO GDP, ANY SIGNALING PRICE RISE IS DUE TO
EXCESS DEMAND IN THE ECONOMY.
• IT TELLS THAT INFLATION CAN BE CONTROLLED BY CHECKING
AGGREGATE DEMAND.
DISADVANTAGES
• THE EXCESS GAP BETWEEN THE CURRENT INCOME, CURRENT EXPENDITURE,
AND CURRENT CONSUMPTION IS TAKEN WHEREAS CORRESPONDING FACTORS
ALREADY PRODUCED IN THE ECONOMY ARE IGNORED IN THE ANALYSIS.

• INFLATION IS NOT A STATIC PROCESS. IT KEEPS ON CHANGING WITH

IMPROBABLE AND VARYING DEGREES. HOWEVER, THE STUDY OF THE
INFLATIONARY GAP IS FOUNDED ON STATIC NATURE BASIS.

• THE NEGLIGENCE OF THE FACTOR MARKET IN AFFECTING THE INFLATIONARY

GAP IS A WEAKNESS OF THE CONCEPT.
IMPORTANT POINTS TO NOTE

1.IT CAN BE REDUCED BY INCREASING SAVINGS SUCH THAT AGGREGATE DEMAND IS REDUCED.
2.WHEN THE INFLATIONARY GAP IS IN PLAY, IT IS VERY DIFFICULT TO INCREASE PRODUCTION BECAUSE ALL
RESOURCES HAVE BEEN UTILIZED.
3.IF GOVERNMENT SPENDING, THE TAX GENERATES, SECURITIES ISSUES ARE CURBED, THE INFLATIONARY GAP
MIGHT BE REDUCED.
4.IT SHOULD BE REMEMBERED THAT THE COINCIDENCE OF ACTUAL INCOME AND FULL EMPLOYMENT INCOME, AS
DESCRIBED IN THE DIAGRAM ABOVE, GIVE RISE TO THE ABSENCE OF AGGREGATE DEMAND, AND CONSEQUENTLY
NO SIGNIFICANT UNEMPLOYMENT CAN EXIST IN THIS SITUATION.
5.BANKS AND FINANCIAL INSTITUTION PLAY THEIR ROLE IN REGULATING THE INFLATIONARY GAP. THEY DO THIS
BY CHECKING THE MONEY SUPPLY IN THE ECONOMY.
CONCLUSION

THE INFLATIONARY GAP IS AN OUTPUT GAP, ALSO TERMED AT THE

GDP GAP WHICH FUNCTIONS ON TWO INDICATORS – REAL AND
ANTICIPATED GDP. IF THE QUANTITY OF EXPENDITURE IN ANY
ECONOMY RISES ABOVE NATIONAL INCOME DUE TO FULL
EMPLOYMENT, THERE IS AN INFLATIONARY GAP.
PROJECT BY : RAVINDRA PHADKE SIR
NAME : ROHIT RAJU PURSWANI
THANKYOU