Stagflation and inflationary gap, stagflation, inflation, inflationary gap,excess demand

1. STAGFLATION AND
INFLATIONARY GAP
Presented by
VAGHELA NAYAN
SDJ INTERNATIONAL COLLEGE

2. Stagflation:
 Meaning: It is a combination of stagnation and
inflation. In this situation rate of unemployment is
very high and prices are also rising. While economic
growth rate is very low. We may find some features
of inflation and recession. In this situation
unemployment and inflation co-exist side by side.

3. Causes of Stagflation
1. If the prices of raw material and labour increases, it
will increase the cost of production prices will rise
and output will fall.
2. Rapid rise in indirect taxes also increase the cost and
price level. So output and employment falls.
3. Shortage of labour also affects the output adversely.

4. DIAGRAM

5.  In this diagram aggregate supply curve (SS)
intersect the aggregate demand curve (DD) at
the point "G". The price level is "OL" and
employment level is "OC" when aggregate
supply curve moves upward the new
equilibrium point of the economy is "F" so
due to the fall in supply price increases from
OL to OK and employment level falls from
OC to OB.

6. MEASURES
1. To reduce the employment training and skill should be
provided to the labour.
2. Money wages should rise with the rise in production.
3. To reduce the cost of production taxes should be reduced.
4. During stagflation govt. should make every effort to control
the wages.
5. Tax concession should be given to those firms which keep the
wages below the target.
6. Those firms which do not control the wages must pay the
penalty.

7. Inflationary gap
 Meaning: When in an economy, aggregate demand is in excess
of ‘aggregate supply at full employment’, the demand is called
an excess demand.
 Alternatively when aggregate demand exceeds ‘aggregate
supply at full employment level the demand is said to be an
excess demand and the gap is called inflationary gap. The gap
is called inflationary because it causes inflation (continuous
rise in prices) in the economy.

8. Example
 Let us suppose that an imaginary economy by employing all
its available resources can produce 10,000 qtls of rice. If
aggregate demand for rice is, say, 12,000 qtls., this demand
will be called an excess demand because aggregate supply at
the level of full employment of resources is only 10,000 qtls.
As a result, the excess of 2,000 qtls will be called an
inflationary gap.

9. Diagram

10.  This situation is depicted in the diagram. Here, point E lying
on 45° line is the full employment equilibrium point. This is
an ideal situation because aggregate demand represented by
EM is equal to full employment level of output (aggregate
supply) represented by OM.
 Suppose, the actual aggregate demand is for a level of output
BM which is greater than full employment level of output EM
(OM). The difference between the two is EB (BM – EM)
which is a measure of inflationary gap or excess demand.

11. Causes of Inflationary Gap
 Increase in household consumption demand due to rise in
propensity to consume.
 increase in private investment demand because of rise in
credit facilities.
 increase in public (government) expenditure.
 increase in export demand.
 increase in money supply (deficit financing) or increase in
disposable income (due to fall in rate of taxes).

12. Causes of Excess Demand
 Deficit financing (printing of currency notes),
 Increase in Marginal Propensity to consume
 Increase in autonomous investment.

13. Thank You