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Magazine Chapter 1: Q.3 (page 9)
Use the AD/AS model to explain how an inflationary gap occurs, beginning from the initial equilibrium in Figure 12.6.
Short Answer
An inflationary gap develops when consumption and investment spending surpass full employment.
Step by step solution
Introduction
The difference between actual real GDP versus GDP that would be created if an economy were fully employed is referred to as the inflationary gap.
Explanation
It simply indicates that consumers want to see more products and services than are now available. In other terms, the inflationary gap is the difference between real aggregate demand and the full employment level of national income.
In the picture above, income is displayed on the axis, while total spending is plotted on the axis.
The intersection between aggregate demand and aggregate supply is where equilibrium is found.
The point E, which is the equilibrium level at full employment, is where the AD and AS curves cross.
As aggregate demand rose, the AD curve shifted upward from AD to AD1. The difference between actual and projected AD is known as the inflationary gap. The FE is thought to be a source of inflation.
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