● Inflationary gap concept that explains the difference between the current level of real gross domestic product and the anticipated

● Gross Domestic Product that would be experienced if the economy is experiencing the functioning at full employment.

● It is also called the potential GDP.

● The inflationary gap is related to the business cycle expansion and increases when the equilibrium level of an economy's aggregate output is greater than the output that could be produced full employment.

● This theory can be used to explain the concept of the inflationary gap.

● This concept was given by him to measure the pressure of inflation and the economy.

● Aggregate demand or aggregate expenditure consists of consumption expenditure C, investment expenditure I, government expenditure G and the trade balance or the value of the export minus value of imports X-M.

● The inflationary gap is the result of excess demand. The excess of the planned level of Expenditure over the available output at the base price.

It can be explained by the following diagram:

● In the above figure, X-axis shows the national income and the Y-axis shows the aggregate demand.

● O is the 45-degree line showing the aggregate supply side. AD is the aggregate demand curve.

● When the demand increases to AD’, the excess demand or the inflationary gap is by AB.

● This is because at full employment Y’, the aggregate demand BY’ is greater than the aggregate supply AY’.

The inflationary gap affects output and price in the following manner:

a. Effect on output: The inflationary gap has no effect on the level of output in an economy. The economy is already at full employment.

b. Effect on prices: The inflationary gap leads to a rise in the general price level in an economy. It occurs when the aggregate demand exceeds the aggregate supply at a full-employment level. It leads to inflation in an economy.

It can be corrected by the following methods:

a. Increasing bank rate

b. Increasing the tax rate.