Question

Explain the concept of excess demand and Inflationary gap with the help of diagram. How can it be corrected by the government?

Answer 1

Inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. It implies two things-

1) Planned aggregate demand in the economy happens to exceed its full employment level.

2) The level of aggregate demand surpasses the level of aggregate supply even when the available factors are fully utilized.

In this diagram, EF represents the excess demand or inflationary gap.

A decrease in government expenditure during excess demand or inflation causes withdrawal of expenditure in the economy. As a result, aggregate demand, purchasing power, and money supply get decreased. Thus, the problem of excess demand or inflationary gap in the economy gets combated