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This unit introduces the concept of full employment equilibrium, inflationary 
and deflationary gaps. it explain in a clear term, using graphical illustration for 
each of the aforementioned concepts. the unit examined various equilibrium 
level within the capitalistic economy as explain by both Keynesian and classical 
At the end of this unit student should be able to;
i) Understand the concepts full employment equilibrium. 
ii) Understand and explain inflationary gap.
iii) Understand the deflationary gap.
iv) Know those factors that can bring about both inflationary and deflationary gaps.
v) Understand and explain graphically, the concepts of inflationary and deflationary gaps.
vi) Understand difference between full employment equilibrium, inflationary and deflationary gaps.
vii) Understand and explain factor(s) that could bring about change fromone equilibrium to the other.
viii) Examine inflationary and deflationary gaps in the light of macroeconomic imbalances

Full Employment Equilibrium

Consider first the case where the economy is at full employment equilibrium. We 
illustrate this in Fig. 4.3(a) In this case, aggregate demand (AD) is equal to aggregate supply (AS) and full employment equilibrium is Y
 The economy‘sresources are fully utilized. Deviations from this norm cause problems of inflation or deflation.

Self Assessment Exercise
i. Graphically explain the full employment equilibrium. 
ii. Does full employment really exists.

Inflationary Gaps

Recall that the basic thrust of Keynesian economics as discussed earlier is to 
demonstrate that, in a capitalistic system, the economy can achieve equilibrium 
at any point within the system. This means that one can talk about full employment equilibrium, less than full employment equilibrium, more than full employment equilibrium. These ideas can be analyzed in terms of two basic 
concepts: the inflationary and deflationary gaps. Let us defined and graphically 
illustrate each of these terms.
The inflationary gap is the amount by which aggregate demand exceeds aggregate supply at full employment (Y) . It is often characterized by an increase 
in general price levels and constant real output. This gap can be removed by
policies that move AD down to e0 as shown in panel (b). We shall consider such
policies in subsequent chapters.
Self Assessment Exercise
i. Graphically explain the inflationary gap
ii. What factor could necessitate inflationary gap

Deflationary Gap

The deflationary gap measures the amount by which aggregate demand falls
short of aggregate supply at the full employment equilibrium position (Y) . This
gap is sometimes called a recessionary gap and is shown in panel (c) of Fig. 4.3b. 
It is often characterized by declining prices, unemployment and increased 
accumulation of inventory. To remove this gap, the policy thrust would be to 
shift AD up to e2.
It should be noted that the concepts of inflationary and deflationary gaps are 
rather extreme and simplistic ways of depicting inflationary and deflationary 
phenomena. In real life economy, things are much more complex. The notions 
are useful, however, as benchmarks for policy analysis of deviation from the full 
employment norm. in subsequent chapters we shall analyse the monetary and fiscal tools for dealing with these problems.
Deflationary gaps fig. 4.3.1(c)

Self Assessment Exercise
i. Graphically explain the inflationary gap
ii. What factor could responsible for the inflationary gap


This unit concludes that every economy is faced with different level of equilibrium which could result to any of the aforementioned gaps but could also 
be resolve through application of macroeconomic tools.


This unit looked at the concept of full employment equilibrium amidst inflationary and deflationary gaps. The unit further explained through graphical 
illustration the process that the two gaps (i.e. inflationary and deflationary gap)
involves in a clear cut terms.

Marked Assignment

i. Graphically, explain the concept of full employment equilibrium.
ii. Explain in a clear term perhaps with graphical illustration what is meant by 
inflationary and deflationary gaps.
iii. Differentiate between full employment equilibrium, inflationary and 
deflationary gaps.
iv. Discuss the factor that could bring about situation of both inflationary and 
deflationary gaps
v. Examine inflationary and deflationary gaps in the light of macroeconomic

References/Further Readings

Attah B.O, Bakare Aremu, T.A. & Daisi, O.R., (2011); Anatomy of Economics 
Principles, Q&A (Macroeconomics), Raamson Printing Press, Oke-Afa, Isolo, 
Lagos, Nigeria
Amacher, R and Ulbrich, H, (1986); Principles of Economics, South Western
Publications Co. Cincinnafi, Oliso
Bakare –Aremu T.A, (2013); Fundamental of Economics Principles
(Macroeconomics), Raamson Printing Press, Oke-Afa, Isolo, Lagos, Nigeria
Bakare I.A.O, Daisi, O.R., Jenrola, O.A., & Okunnu, M.A., (1999): Principles 
and Practice of Economics (Macro Approach), Raamson Printing Press, 
Mushin, Lagos, NigeriaDennis R. A. et-al; International Economics, Mcgraw 
Hill Irwin, 8th edition.
Familoni K.A, (1990); Development in Macroeconomics Policy, Concept
Publications, Lagos, Nigeria
Fashina E.O, (2000); Foundations of Economics Analysis (Macro Theories),
F.E.F International Company, Ikeja, Lagos, Nigeria
Jhingan M.L, (2010); Macroeconomics Theory, 12th edition, Vrinda
Publications (P) Ltd. Delhi, India
Jhingan M.L, (2010); International Economics, Vrinda Publications (P) Ltd. 
Delhi, India
Lipsey R.G, (1979); An Introduction to Positive Economics, Hayper & Raw, 
Umo J.U, (1986); Economics; An African Perspectives , Johnwest, Lagos
Gordon Robert J. (2009). Macroeconomics (Eleventh ed.). Boston: Pearson
Addison Wesley. ISBN 9780321552075

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