Fig. 94 Inflationary gap.
(a) the AGGREGATE SUPPLY SCHEDULE
is drawn as a 45-degree line because businesses will offer any particular level of output only if they expect total spending (aggregate demand) to be just sufficient to sell all that output. However, once the economy reaches the full employment level of national income (OY1
), then output cannot expand further and at this level of output the aggregate supply schedule becomes vertical. If aggregate demand was at the level indicated by AD, the economy would be operating at full employment without inflation (at point E). However, if aggregate demand was at a higher level like AD1
this excess aggregate demand would create an inflationary gap (equal to EG), pulling price upward.
(b) Alternatively, where aggregate demand and aggregate supply are expressed in terms of real national income and price levels, an inflationary gap shows up as the difference between the price level (OP) corresponding to the full employment level of aggregate demand (AD) and the price level (OP1) corresponding to the higher level of aggregate demand (AD1) at real national income level OY 1. See DEMAND-PULL INFLATION.