Inflationary Gap


DEFINITION of 'Inflationary Gap'

A macroeconomic condition that describes the distance between the current level of real gross domestic product (GDP) and full employment (long run equilibrium) real GDP. The inflationary gap is so named because the relative increase in real GDP causes an economy to increase its consumption, which causes prices to rise in the long run.


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BREAKING DOWN 'Inflationary Gap'

According to macroeconomic theory, the goods market determines the level of real GDP, which is shown in the following relationship:

Inflationary Gap

As illustrated above, an increase in consumption expenditure, investments, government expenditure or net exports will cause real GDP to rise in the short run.

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