Distinction between Inflationary and Deflationary Gap at the Equilibrium Level of Income!

Inflationary Gap:

Inflationary gap is the amount by which the actual aggregate demand exceeds ‘aggregate supply at level of full employment’.

The diagram above shows that the bigger the inflationary gap, the smaller the level of national income since income increases from Y_f to Y_E. Also,

Inflationary gap causes a rise in price level which is called inflation and leads to an increase in employment and income.

Deflationary Gap:

Deflationary gap is the amount by which aggregate demand falls short of aggregate supply at level of full employment’.  As shown in the figure below deflationary gap is a measure of amount of deficiency of aggregate demand.

The bigger the gap the national income since the income increases from Y_E to Y_f.

Deflationary gap causes a decline in output, income and employment along with persistent fall in prices.

Conclusion:

Equilibrium level of national income is determined by the equality between aggregate demand and aggregate supply (or between savings and investment). An ideal situation for an economy is full employment equilibrium, i.e., when its aggregate demand and aggregate supply are in equilibrium at such a point where all the resources of the economy are fully employed.

Excess demand results in inflation without an increase in output and employment whereas deficient demand leads to unemployment and fall in output, income and prices.

Both the situations bring harmful effects on the economy and, therefore, require to be checked by adopting fiscal, monetary and other measures to achieve and stay at the equilibrium level of income where there is full employment of all the available resources.