Question

What is the difference between inflationary gap and deflationary gap?

Hint:

An inflationary gap leads to inflation, while a deflationary gap leads to unemployment and deflation.

Answer 1

Step 1: Defining Inflationary Gap:
An inflationary gap occurs when the actual output of an economy exceeds its potential output, leading to upward pressure on prices. In this situation, aggregate demand exceeds aggregate supply at full employment, causing inflation. The economy is "overheating" and is producing more than its sustainable level.
Step 2: Defining Deflationary Gap:
A deflationary gap occurs when the actual output of an economy is less than its potential output. This situation arises when aggregate demand is insufficient to purchase the total output that can be produced at full employment, leading to a decrease in prices and output. The economy is underperforming, and there is unused capacity in the economy.
Step 3: Key Differences:
- Inflationary Gap: The economy is producing more than its potential, leading to inflationary pressures.
- Deflationary Gap: The economy is producing less than its potential, leading to unemployment and deflationary pressures.
Step 4: Final Conclusion:
The inflationary gap occurs when demand exceeds supply, causing inflation, while the deflationary gap occurs when demand is less than supply, causing underemployment and deflation.