What is inflationary gap and deflationary gap?

Excess demand or inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. Deficient demand or deflationary gap refers to the situation when aggregate demand is short of aggregate supply corresponding.

What can cause a deflationary gap?

Causes of Deflation

• Fall in the money supply. A central bank.
• Decline in confidence. Negative events in the economy, such as recession, may also cause a fall in aggregate demand.
• Lower production costs.
• Technological advances.
• Increase in unemployment.
• Increase in the real value of debt.
• Deflation spiral.

How does excess demand cause inflation?

A surge in demand for products and services can cause inflation as consumers are willing to pay more for the product. Some companies reap the rewards of inflation if they can charge more for their products as a result of the high demand for their goods.

What is deflationary gap in economy?

Definition of deflationary gap : a deficit in total disposable income relative to the current value of goods produced that is sufficient to cause a decline in prices and a lowering of production — compare inflationary gap.

What is deflationary gap example?

For example, deflationary gap is the amount by which aggregate demand must be increased to push the equilibrium level of income through the multiplier to the full employment level. In other words, if current national income is below full employment national income, a deflationary gap will arise.

What are the causes of inflationary and deflationary gap?

What Causes an Inflationary Gap? Inflationary gaps occur when aggregate demand is higher than the projected demand, which can be caused by two different things: A rise in aggregate demand. A rise in demand will naturally create a discrepancy between real demand and potential demand.

What is excess demand and inflationary gap?

Excess demand- refers to the situation when aggregate demand (AD) is more than the aggregate supply (AS) corresponding to full employment level of output in the economy . Inflationary gap refers to the gap by which actual aggregate demand exceeds the aggregate demand required to establish full employment equilibrium .

Who wrote Modified Phillips curve?

Work by George Akerlof, William Dickens, and George Perry, implies that if inflation is reduced from two to zero percent, unemployment will be permanently increased by 1.5 percent. This is because workers generally have a higher tolerance for real wage cuts than nominal ones.

What is new Keynesian Phillips curve?

The New Keynesian Phillips curve (NKPC) is a widely used structural model of inflation dynamics. Its key parameter, which governs the pass-through of marginal costs into inflation, is the average time over which prices are kept fixed. This average price duration provides a measure for the degree of price stickiness.

What is meant by inflationary gap?

Inflationary gap is the amount by which the actual aggregate demand exceeds ‘aggregate supply at level of full employment’. For instance, in Fig. 8.16, BE is shown as inflationary gap. It is a measure of the excess of aggregate demand over level of output at full employment.

What is the difference between excess and deficient demand?

The demand causing inflationary gap is called excess demand, whereas the demand which results in a deflationary gap is deficient demand.

How do you reduce the deflationary gap in the economy?

This gap, however, can be reduced either by reducing money income through reduction in government expenditure, or by increasing output of goods and services, or by increasing taxes. If the equilibrium level of income is estimated to be below the full employment level of income then emerges deflationary gap.

Is EB deflationary or deflationary gap?

For instance, in Fig. 8.17, EB is shown as deflationary gap. It is a measure of amount of deficiency of aggregate demand. Deflationary gap causes a decline in output, income and employment along with persistent fall in prices.