Inflationary gap (positive output gap)

Definition

An inflationary gap refers to the situation when the actual level of Real GDP exceeds the potential level of Real GDP, leading to upward pressure on prices in the economy.

Analogy

Imagine a classroom where there are more students than available seats. The overcrowding creates a situation where some students have to stand, causing discomfort and pushing everyone closer together. Similarly, an inflationary gap occurs when there is excess demand in the economy, leading to price increases and economic strain.

Related terms

Potential GDP: The maximum level of Real GDP that an economy can produce without causing inflation.

Demand-pull inflation: A type of inflation caused by excessive aggregate demand in relation to aggregate supply.

Phillips curve: A graphical representation showing the inverse relationship between unemployment rate and inflation rate.