Expansionary Gap

Definition

An expansionary gap occurs when the actual level of output in an economy exceeds its potential level of output. This means that the economy is operating above its full capacity and resources are being overutilized.

Analogy

Imagine a water tank that has a maximum capacity of 100 liters. However, due to a malfunction, the tank is currently holding 120 liters of water. This excess amount represents the expansionary gap, where the tank is being overloaded beyond its intended capacity.

Related terms

Inflation: Inflation refers to a sustained increase in the general price level of goods and services in an economy. It can be one consequence of an expansionary gap.

Aggregate Demand: Aggregate demand represents the total amount of goods and services that households, businesses, and governments are willing to purchase at different price levels.

Fiscal Policy: Fiscal policy involves government actions related to taxation and spending with the aim of influencing aggregate demand and stabilizing economic conditions.