Excess Demand & Inflationary Gap

Excess Demand & Inflationary Gap,

Meaning:
When aggregate demand exceeds ‘aggregate supply at full employment level the demand is said to be an excess demand and the gap is called inflationary gap.

This situation is depicted in Fig. Here, point E lying on 45° line is the full employment equilibrium point. This is an ideal situation because aggregate demand represented by EM is equal to full employment level of output (aggregate supply) represented by OM.

Suppose, the actual aggregate demand is for a level of output BM which is greater than full employment level of output EM (OM). The difference between the two is EB (BM – EM) which is a measure of inflationary gap or excess demand.

Inflationary Gap

It is a measure of the amount of excess of aggregate demand over ‘aggregate supply at full employment’.

Causes of Excess Demand:

These are:

(i) Deficit financing (printing of currency notes), (ii) Increase in Marginal Propensity to consume and (iii) Increase in autonomous investment.

Impact of Excess Demand:

Briefly, it causes rise in prices and increases in equalities:

It does not lead to an Increase in output and employment.