Q. With reference to the inflationary gap, consider the following statements:
1.An inflationary gap exists when the aggregate demand exceeds the aggregate supply at the full employment level of output.
2.It is a symptom of an overheated economy where there is excess aggregate demand.
3.The presence of an inflationary gap tends to exert downward pressure on prices due to the excess supply of goods.
Which of the statements given above is/are correct?
Answer: A
Notes:
Explanation:
- Statement 1: An inflationary gap is the difference between the actual level of aggregate demand and the level of aggregate demand required to achieve full employment without causing inflation. It occurs when actual demand surpasses the economy’s productive capacity at full employment.
- Statement 2: The existence of an inflationary gap indicates that there is more money chasing a limited supply of goods and services, which is a classic sign of an overheated or booming economy.
- Statement 3: The presence of an inflationary gap leads to upward pressure on prices, not downward pressure. The excess demand causes firms to raise prices, leading to inflation. Downward pressure on prices would be a symptom of a deflationary gap.
