C3 HANDOUT

Deflationary Gap & Inflationary Gap

DEFLATIONARY GAP INFLATIONARY GAP

DEFINITION
Ye < Yfe Ye > Yfe
National income equilibrium < national National income equilibrium > national income equilibrium
income equilibrium at full employment at full employment
CAUSES
AD = AS I=S AD = AS I=S
 Deficiency in  Total  Increase in general price level  Total injections
spending withdrawal > @ nominal income (not real > total
 Resources are not total injection increases in goods & services) withdrawal
fully utilized  Excess demand (AD increase)
 Any increases in  When AD (C+I+G+(X-M))
Ye is a real above Fe, there is inflationary

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increase gap
 When AD
(C+I+G+(X-M))
is below Fe, there
is deflationary
gap

ECO 211/NORANITA/ECONOMICS LECTURER

 C3 HANDOUT

TO CLOSE
Combination of the two policy until Ye = Yfe
AD = AS I=S AD = AS I=S
Expand more but not toward inflation Deliberate government policy of deflation
 Expansionary  Injection  Deflationary/Contractionary  Injection
Monetary policy Withdrawal Monetary policy ( Withdrawal
(Ms , r ) Ms , r )
 Expansionary  Deflationary/Contractionary
Fiscal policy Fiscal policy ( G T )
(G T )
GRAPH
AD = AS I=S AD = AS I=S

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Y Yfe
Yfe Y
Y Yfe Yfe Y

ECO 211/NORANITA/ECONOMICS LECTURER