What is an inflationary gap?

• A. A situation in which actual real GDP (equilibrium GDP) is above potential (full-employment) GDP, producing upward pressure on prices and low unemployment.
• B. A situation in which long-run aggregate supply shifts right faster than aggregate demand, causing temporary inflationary pressure.
• C. A situation in which high inflation is caused solely by cost-push factors without any output gap.
• D. A situation in which actual real GDP is below potential GDP, resulting in cyclical unemployment and unused capacity.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of potential GDP, which represents the level of real GDP when the economy is at full employment, meaning all resources are used efficiently without causing inflationary pressure.
2. Step 2: Recognize that actual real GDP (or equilibrium GDP) is the output level determined by aggregate demand and aggregate supply in the short run.
3. Step 3: Define an inflationary gap as the situation where actual real GDP exceeds potential GDP, indicating the economy is producing beyond its sustainable capacity.
4. Step 4: Explain that this excess demand puts upward pressure on prices, leading to inflation, and typically corresponds with very low unemployment because resources are fully utilized or over-utilized.
5. Step 5: Contrast this with other scenarios such as a recessionary gap (actual GDP below potential GDP) or cost-push inflation, to clarify that an inflationary gap specifically involves output above full employment causing demand-pull inflation.