Inflationary Gap occurs when AD > AS corresponding to full employment level. This inflationary gap, i.e., excess of aggregate demand causes inflation in the economy and price levels tend to rise.
In the above figure,
ADFE = AD at full employment level
ADAE = AD above full employment level
The point E is the equilibrium point where AD = AS. But the excess demand (current) of ADAE, aggregate demand FP is more than the aggregate supply in the economy. This difference of actual aggregate demand and supply i.e., EF is the Inflationary Gap.
Inflationary Gap = Excess Demand
= ADAE – ADFE
= EF
Monetary measures to correct inflationary gap are :
(i) Rise in bank rate
(ii) Sale of securities in open market
(iii) Rise in Cash reserve Ratio
(iv) Increase in Liquidity Ratio
(v) Increase in Margin Requirement of money
(vi) Credit Rationing
