Inflationary And Deflationary Gaps
Economics notes
Inflationary And Deflationary Gaps
➡️ Full employment level of national income is the level of income at which all available resources are fully utilized and there is no cyclical unemployment. It is also known as the natural level of national income.
➡️ Equilibrium level of national income is the level of income at which aggregate demand and aggregate supply are equal. It is the level of income at which the economy is in a state of balance and there is no inflationary or deflationary pressure.
➡️ The difference between the full employment level of national income and the equilibrium level of national income is known as the output gap. This gap indicates the degree of slack in the economy and can be used to measure the degree of economic activity.
What is an inflationary gap and how does it affect the economy?
An inflationary gap occurs when the actual output of an economy exceeds its potential output, leading to an increase in prices and inflation. This can happen when there is excess demand for goods and services, which leads to higher prices and a decrease in the purchasing power of consumers. In the short term, an inflationary gap can lead to economic growth and increased employment, but in the long term, it can lead to higher inflation and a decrease in the standard of living.
What is a deflationary gap and how does it affect the economy?
A deflationary gap occurs when the actual output of an economy is less than its potential output, leading to a decrease in prices and deflation. This can happen when there is insufficient demand for goods and services, which leads to lower prices and a decrease in the profitability of businesses. In the short term, a deflationary gap can lead to decreased economic growth and increased unemployment, but in the long term, it can lead to lower inflation and an increase in the standard of living.
How can policymakers address inflationary and deflationary gaps in the economy?
To address an inflationary gap, policymakers can use contractionary monetary policy, such as raising interest rates or reducing the money supply, to decrease demand and reduce inflation. They can also use fiscal policy, such as reducing government spending or increasing taxes, to decrease demand and reduce inflation.
To address a deflationary gap, policymakers can use expansionary monetary policy, such as lowering interest rates or increasing the money supply, to increase demand and stimulate economic growth. They can also use fiscal policy, such as increasing government spending or reducing taxes, to increase demand and stimulate economic growth.