Inflationary Gap

Inflationary Gap – An inflationary gap arises when the actual output (real GDP) of an economy exceeds its potential output at full employment. This situation indicates that aggregate demand surpasses aggregate supply, pushing prices upward and causing demand-pull inflation. Such a gap reflects an overheated economy, often triggered by excessive consumer spending, increased government expenditure, or high levels of investment and exports. To control inflationary pressure, governments may adopt contractionary fiscal and monetary policies. Example: If an economy’s potential GDP is ₹10 trillion but its actual GDP rises to ₹10.5 trillion due to excessive demand, the ₹0.5 trillion represents the inflationary gap — leading to rising prices and inflation..