what is an inflationary gap 
an inflationary gap measures the difference between the current level of real gross domestic product gdp and the gdp that would exist if an economy was operating at full employment understanding an inflationary gapan inflationary gap exists when the demand for goods and services exceeds production due to higher levels of employment increased trade activities or elevated government expenditure the real gdp can exceed the potential gdp resulting in an inflationary gap inflationary gap actual gdp anticipated gdp begin aligned text inflationary gap text actual gdp text anticipated gdp end aligned inflationary gap actual gdp anticipated gdp the inflationary gap represents the point in the business cycle when the economy expands as consumers purchase more goods and services as demand increases but production lags prices rise to restore market equilibrium the real gdp must be higher than the potential gdp for the gap to be considered inflationary when the potential gdp is higher than the real gdp the gap is instead referred to as a deflationary gap calculating real gross domestic product gdp gdp measures the monetary value of final goods and services produced in a given period and bought by the final user within an economy gdp is composed of goods and services for sale in the market and includes some nonmarket output such as defense or education services provided by the government 1according to macroeconomic theory the goods market determines the real gdp shown in the following relationship to calculate real gdp first compute the nominal gdp y c i g nxwhere y nominal gdpc consumption expenditurei investmentg government expenditurenx net exports begin aligned text y text c text i text g text nx textbf where text y text nominal gdp text c text consumption expenditure text i text investment text g text government expenditure text nx text net exports end aligned y c i g nxwhere y nominal gdpc consumption expenditurei investmentg government expenditurenx net exports then the real gdp y d where d is the gdp deflator which takes inflation into effect over time an increase in consumption expenditure investments government expenditure or net exports causes real gdp to rise in the short run real gdp provides a measure of economic growth while compensating for the effects of inflation or deflation this accounts for the difference between actual economic growth and a simple shift in the prices of goods or services within the economy fiscal and monetary policy to manage the inflationary gapa government may use fiscal policy to help reduce an inflationary gap by decreasing the number of funds circulating in the economy this is accomplished through reductions in government spending tax increases bond and securities issues and transfer payment reductions these adjustments to the fiscal conditions within the economy can restore economic equilibrium as the amount of money in circulation decreases the overall demand for goods and services declines reducing inflation central banks also have tools at their disposal to combat inflationary activity when the federal reserve fed raises interest rates borrowing funds is more expensive tight monetary policy can lower the money available to most consumers triggering less demand and inflation retreats once equilibrium is reached the fed or other central bank can shift interest rates accordingly 