DEFINITION of 'Above Full-Employment Equilibrium'

Above full-employment equilibrium is a macroeconomic term used to describe a situation in which an economy’s real gross domestic product (GDP) is in excess of its long-run potential level. Accordingly, the amount that the current real GDP is greater then the historic average is called an inflationary gap, as this will create inflationary pressures in this particular economy.

BREAKING DOWN 'Above Full-Employment Equilibrium'

An economy that is operating above its full-employment equilibrium simply means that it is producing goods and services, as measured by its GDP, at a higher level than either its potential or its long-run average levels. The amount by which the current real GDP is greater than the historic average is called an inflationary gap. When the market is in equilibrium, there will not be any excess supply in the short run. But an overly active economy will create more demand for goods and services, which will push prices and eventually wages upward, as companies increase production to meet demand. Ultimately, this results in a situation of too much money chasing too few goods, and creates inflationary pressures in the economy, which isn’t sustainable for long periods.

For one thing, companies can only ramp up production so much before hitting capacity constraints. So increases in supply will be finite. Over time, the economy and employment markets will shift back into equilibrium as higher prices bring demand back down to normal run-rate levels.

Reasons An Economy Might Be Above Full-Employment Equilibrium

When an economy is at full employment, a level that varies by economy and can change over time, all available labor is being utilized. A number of factors can cause employment to rise beyond its equilibrium level. A significant shift in demand, or “demand shock," government spending, for example, a buildup in military spending to support war effort; or through government stimulus, such as a tax cut, can push demand high enough to exceed full employment. A good example of the former is the growth of the U.S. economy during World War II. These types of demand-stimulating activities from government is known as expansionary fiscal policy.

An increase in the demand for a country’s goods and services — greater export demand — as well as an increase in household consumption, can cause an inflationary gap.

Fiscal policies such as increasing taxes or reducing spending and/or monetary policy (central bank) actions or increasing the level of interest rates can be used to bring an overheating economy back into equilibrium. But these take time to make an impact, and also come with risks of overcorrecting and causing a recessionary gap.

  1. Competitive Equilibrium

    A competitive equilibrium is when profit-maximizing producers ...
  2. General Equilibrium Theory

    General equilibrium theory studies supply and demand fundamentals ...
  3. Equilibrium

    Equilibrium state in which market supply and demand balance each ...
  4. Recessionary Gap

    A recessionary gap is a macroeconomic term that describes the ...
  5. Below Full Employment Equilibrium

    Below full employment equilibrium occurs when an economy's short-run ...
  6. Law of Supply and Demand

    The law of supply and demand explains the interaction between ...
Related Articles
  1. Investing

    What is Deadweight Loss?

    Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  2. Insights

    The GDP and its Importance

    GDP is an accurate indication of an economy's size. Few data points can match the GDP and its growth rate's conciseness.
  3. Insights

    The Importance Of Inflation And GDP

    Learn the underlying theories behind these concepts and what they can mean for your portfolio.
  4. Investing

    Impact of the Chinese Economy on the U.S. Economy

    The economic growth of China has been decreasing since 2010. What impact does this have on the US and the world economy?
  5. Financial Advisor

    These Will Be the World's Top Economies in 2020

    Discover the current economic forces that are anticipated to significantly shift the landscape of the world's most powerful economies over the next decade.
  6. Investing

    Which Countries Will Drive Global Growth in 2016?

    Given the volatility that has already shaken the global economy, the world's largest economies will be leaned on to stimulate growth in 2016
  7. Insights

    Introduction to Supply and Demand

    Learn about one of the most fundamental concepts of economics - supply and demand - and how it relates to your daily purchases.
  1. Why are there no profits in a perfectly competitive market?

    See why economic profits are theoretically impossible in a perfectly competitive market and why some economists use perfect ... Read Answer >>
  2. Is demand or supply more important to the economy?

    Learn more about the impact of supply and demand in an economy. Find out why companies study supply and demand as part of ... Read Answer >>
  3. What's the difference between monetary policy and fiscal policy?

    Discover the distinctions between these two tools designed to influence national economies. Read Answer >>
  4. Is gross national income (GNI) or gross domestic product (GDP) a better measure of ...

    Discover why gross national income may be a better metric of an economy than gross domestic product when an economy has substantial ... Read Answer >>
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center