Inflationary gap in an economy may exist when _____ at full employment level. (Choose the correct alternative

Question 72 of 104

Q. Inflationary gap in an economy may exist when __________ at full employment level. (Choose the correct alternative to fill in the blank) (A) Actual Aggregate Demand > Potential Aggregate Demand (B) Actual Aggregate Demand < Potential Aggregate Demand (C) Actual Aggregate Demand \leq Potential Aggregate Demand (D) Actual Aggregate Demand = Potential Aggregate Demand

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Concept understanding — Aggregate Demand Equilibrium

Aggregate Demand Equilibrium: The Economy's Balancing Act

Think of a seesaw. On one side sits everything people, firms, and the government want to buy. On the other side sits everything firms produce. When the seesaw is perfectly level — when total spending exactly matches total output — the economy is in equilibrium. That's the core idea.

But why should you care? Because when the seesaw tilts, real things happen. If spending exceeds output, prices rise (inflation). If output exceeds spending, factories shut down and people lose jobs. Equilibrium is the sweet spot where neither happens.

The Precise Meaning

In macroeconomics, Aggregate Demand (AD) is the total planned spending on final goods and services in an economy during a given period. Aggregate Supply (AS) is the total output firms plan to produce.

Equilibrium occurs where:

AD = AS

At this point, what buyers intend to spend exactly equals what sellers intend to produce. No unwanted inventories pile up, and no shortages force prices up. The economy is "at rest."

Y = C + I + G + (X - M)

This is the AD identity from your NCERT textbook. It tells you that total spending in the economy comes from four sources: households, firms, government, and foreigners (net of what we buy from them).

How Equilibrium Actually Works

Imagine a simple economy with only households and firms. Households earn income $Y$ from firms. They spend part of it on consumption $C$ and save the rest $S$ . Firms produce output and also invest $I$ (buying machines, building factories).

Equilibrium condition becomes:

Y = C + I

But households don't spend all their income. They save. So $C = Y - S$ . Substituting:

Y = (Y - S) + I

Which simplifies to:

S = I

Important

In equilibrium, planned savings must equal planned investment. This is the Keynesian cross condition. If people save more than firms invest, total spending falls short of output — inventories pile up, firms cut production, and income falls until savings and investment match again.

The 45° Line Diagram (Describe It)

Draw a graph with Aggregate Demand (AD) on the vertical axis and National Income (Y) on the horizontal axis.

Draw a 45° line from the origin. Every point on this line represents $AD = Y$ — the equilibrium condition.
Draw the AD curve (which is $C + I + G + (X-M)$ ). It slopes upward because as income rises, consumption rises.
Where the AD curve crosses the 45° line — that's the equilibrium point. …

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An inflationary gap arises when the economy's actual aggregate demand exceeds what it can sustainably produce at full employment — option (A) is correct.

The concept of an inflationary gap

An economy reaches full employment when all available resources (labor, capital, land) are being used at their normal, sustainable capacity. At this point, the economy produces its potential output — the maximum it can deliver without triggering accelerating inflation. Potential aggregate demand is simply the level of spending that would purchase exactly this potential output, keeping the economy in equilibrium at full employment.

Now suppose actual aggregate demand — the total spending by households, firms, government, and foreigners — rises above this potential level. Firms face orders they cannot fill by producing more, because factories are already running at capacity and the labor force is fully employed. Yet the spending is there, chasing the same limited quantity of goods and services. Prices get bid up. This is the inflationary gap: excess demand pulling prices upward even though real output cannot expand further.

The gap itself is measured as the difference between actual aggregate demand and potential aggregate demand (or equivalently, between actual AD and the aggregate supply at full employment). It represents the amount by which spending must fall to bring the economy back to non-inflationary equilibrium.

Watch out

Do not confuse an inflationary gap with a deflationary (or recessionary) gap. A deflationary gap occurs when actual AD falls short of potential AD, leaving resources unemployed and output below capacity — the opposite situation.

Why the other options fail …

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Same / Similar Concept — real previous-year questions on the same or a closely similar concept, not this exact question.

JAC Jharkhand Intermediate Class 12 (Commerce) 2026Set ANNUAL1 markMCQ
$Q. Which of the following is not a component of aggregate demand?$
(a) Consumption expenditure
(b) Investment expenditure
(c) Net export
(d) Expenditure on financial assets
›Reveal solutionSolution

Expenditure on financial assets is not part of aggregate demand.

Aggregate demand = consumption expenditure (C) + investment expenditure (I) + government expenditure (G) + net exports (X − M). Expenditure on financial assets (buying shares, bonds) is only a transfer of existing assets, not spending on newly p …

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JAC Jharkhand Intermediate Class 12 (Commerce) 2025Set ANNUAL1 markMCQ
$Q. In the situation of inflation$
(a) prices of goods decrease
(b) prices of goods increase
(c) value of money increases
(d) production decreases
›Reveal solutionSolution

In inflation, prices of goods increase.

Inflation is a situation in which there is a sustained rise in the general price level of goods and services in an economy over time. As prices rise, the value (purchasing power) of money falls. It usually occurs when aggregate demand exceeds aggregate s …

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JAC Jharkhand Intermediate Class 12 (Commerce) 2024Set ANNUAL1 markMCQ
$Q. How does an increase in the marginal propensity to consume affect aggregate demand?$
(a) There is no change in the aggregate demand curve
(b) The slope of the aggregate demand curve will increase
(c) The aggregate demand curve will shift to the right
(d) The aggregate demand curve will shift to the left
›Reveal solutionSolution

A higher MPC increases the slope of the aggregate demand curve.

The slope of the aggregate demand (consumption + investment) curve depends on the marginal propensity to consume, because MPC is the slope of the consumption function. When MPC increases, each extra rupee of income raises consumption (and hence AD) by more, so the AD curve becomes **steeper — its slope …

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JAC Jharkhand Intermediate Class 12 (Commerce) 2023Set ANNUAL1 markMCQ
$Q. "Supply creates its own demand." Who said this?$
(a) J. B. Say
(b) Adam Smith
(c) Marshall
(d) Pigou
›Reveal solutionSolution

'Supply creates its own demand' is Say's Law, stated by J. B. Say.

The classical proposition that production (supply) generates enough income to buy the whole output, so there can be no general over-production, is known as Say's Law of Markets, named after the French economist Jean-Baptiste Say. Keynes later crit …

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JAC Jharkhand Intermediate Class 12 (Commerce) 2023Set ANNUAL1 markMCQ
$Q. Recession is a state when, in the economy$
(a) Production increases
(b) Employment increases
(c) Employment and production level increases
(d) Employment and production level falls
›Reveal solutionSolution

In a recession, employment and production both fall.

Recession is a downturn phase of the business cycle in which aggregate demand is weak, so firms cut output and lay off workers. As a result both the level of production and the level of employment fall, incomes decline and economic activity contracts. …

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JAC Jharkhand Intermediate Class 12 (Commerce) 2023Set ANNUAL1 markMCQ
$Q. Which is the determining factor for investment?$
(a) Marginal efficiency of capital
(b) Interest rate
(c) Both
(1) and
(2)
(d) None of these
›Reveal solutionSolution

Investment is determined by both the marginal efficiency of capital and the rate of interest.

According to Keynes, the level of investment depends on a comparison of the marginal efficiency of capital (MEC) — the expected rate of return on new investment — with the rate of interest — the cost of borrowing funds. Investment is profitable and is …

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The concept of an inflationary gap

Why the other options fail …

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