Question

Inflationary gap in an economy may exist when ------ at full employment level.

• A. Actual Aggregate Demand $>$ Potential Aggregate Demand
• B. Actual Aggregate Demand $<$ Potential Aggregate Demand
• C. Actual Aggregate Demand $<$ Potential Aggregate Demand
• D. Actual Aggregate Demand = Potential Aggregate Demand

Hint:

An inflationary gap occurs when Aggregate Demand exceeds Aggregate Supply, leading to inflationary pressures in the economy.

Answer 1

The Correct Option is A

An inflationary gap arises when Aggregate Demand (AD) exceeds Aggregate Supply (AS) at full employment level. This results in demand-pull inflation, where excess demand drives prices upward. Key Characteristics of Inflationary Gap:
1. Occurs when actual AD surpasses the productive capacity of an economy.
2. Leads to rising prices and inflation due to excess demand.
3. Creates pressure on wages and resources, pushing costs higher. Conclusion: An inflationary gap is a sign of an overheating economy, requiring contractionary fiscal and monetary policies to control inflation. Thus, option (A) is correct.