Equilibrium GDP and Prices - Inflationary Gap

Equilibrium GDP is the level of output at which the aggregate demand (AD) equals the aggregate supply (AS) in an economy. It represents the level of economic activity that is consistent with stable prices and full employment. When the economy is operating at equilibrium GDP, there is no inflationary or recessionary gap.

However, if the aggregate demand exceeds the aggregate supply at the equilibrium level of GDP, the economy experiences an inflationary gap. This means that there is excess demand in the economy, leading to upward pressure on prices. Inflationary gap occurs when the economy is producing at a level above its potential output.

The inflationary gap is also known as the output gap, and it represents the difference between the actual output of the economy and its potential output. The potential output is the level of output that the economy can produce at full employment, using all its resources efficiently.

To close the inflationary gap, the government can use contractionary fiscal policy measures such as increasing taxes or reducing government spending. The central bank can also use monetary policy measures such as increasing interest rates to reduce aggregate demand and bring it back to the equilibrium level.

In summary, equilibrium GDP represents the level of output at which the economy is operating at full employment and stable prices. An inflationary gap occurs when the economy is producing above its potential output, leading to excess demand and upward pressure on prices. To close the inflationary gap, the government and central bank can use contractionary fiscal and monetary policy measures.