What do you understand by the Inflationary gap ........

Economic and Social Issues Inflation Trends

What do you understand by the Inflationary gap?

It is a situation which arises when Aggregate demand in the economy falls short of Aggregate Supply at the full employment level.

It is a situation when inflation rises at an extremely faster rate.

It is a situation which arises when Aggregate demand in an economy exceeds the Aggregate supply at the full employment level.

The mechanism through which the central banks controls inflation depends on interest rate.

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Explanation:

The Inflationary gap is a situation which arises when Aggregate demand in an economy exceeds the Aggregate supply at the full employment level. An inflationary gap exists when the demand for goods and services exceeds production due to factors such as higher levels of overall employment, increased trade activities, or elevated government expenditure.

Against this backdrop, the real GDP can exceed the potential GDP, resulting in an inflationary gap. The inflationary gap is named as such because the relative rise in real GDP causes an economy to increase its consumption, leading prices to climb in the long run.