INFLATIONARY GAP V DEFLATIONARY GAP

Inflationary Gap V Deflationary Gap

Inflationary Gap V Deflationary Gap

Introduction

Deflationary Gap is an economic term describing the situation when Gross Domestic Product is below its full-employment level. In theory, such a situation would lead to the existence of unemployed resources, which should lead to falling prices (deflation) for those resources as the unemployed ones compete in the market

On the other hand, inflationary Gap refers to the situation when aggregate demand exceeds aggregate supply, thus causing prices to increase if the economy is at full employment, or bringing about increases in production if it is not. It is usually attributed to government operating on deficit, thereby spending more than it receives in taxes and, so, creating excess demand.

Analysis

In the economy the study of increases and decreases in general consumer goods or services prices is referred to as inflation and deflation - respectively. Economists studying inflation or deflation study either a sustained increase or decrease in the general price level over time. The study of such is important as the effect of price levels within society effect all participants in the economy including individuals, business and government.Inflation and deflation is measured by many sources in a variety of ways, depending on how the information is to be used and who by. In Australia, the Australian Bureau of Statistics in the form of the Consumer Price Index (CPI) measures inflation and deflation. The changes in the CPI reflect the levels of inflation or deflation, which in turn encapsulates the real cost of living. The CPI is measured by the use of a "basket of goods and services", all the goods and services are priced in one year and then again the following year, changes in prices can then be used to calculate inflation or deflation.

The economy goes through periods of "booms" and "slumps". These ups and downs are called the trade cycle. The long run trend line represents the full-employment position. When national income is equal to the full-employment level unemployment is at a minimum and there are no inflationary or deflationary pressures. During a boom the national income level rises above the full-employment equilibrium level. Workers are put under pressure to work more hours by doing overtime. They respond in the short-run because they are attracted by the prospect of higher pay. There is upwards pressure on wages, which leads to increased costs. Firms run down their stocks to meet the excess demand; the demand conditions invite firms to increase their prices. The result of a boom is to create inflation. The pressure is called an inflationary gap. The inflationary gap is the amount by which the actual expenditure in the economy is in excess of the level of expenditure required for full employment.

The economy has its own built-in stabilisers. The inflation during a boom causes export prices to rise; this in turn causes a decrease in demand for exports, which deflates the economy. The government also responds by increasing interest rates to dampen ...