An Inflationary Gap is a macroeconomic concept that measures the difference between the current level of real GDP and the gross domestic product (GDP) that would exist if an economy was operating at full employment.
The 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 increased government expenditure.
The Inflationary Gap is thus the result of excess demand. It may be defined as the excess of
planned levels of expenditure over the available output at base prices.
This can lead to the real GDP exceeding the potential GDP, resulting in an inflationary gap. The
The Inflationary Gap is so named because the relative increase in real GDP causes an economy to increase its consumption, which causes prices to rise in the long run.
The deflationary gap is the difference between potential output at the full level of employment and the actual level of output of the economy. For the deflationary gap, all the resources of the economy are not being used to the optimum level and some are idle. This comes with unemployment and low levels of output.