Above Full Employment Equilibrium Explained

What Is 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 higher than usual, which means it is in excess of its long-run potential level.

Understanding Above Full Employment Equilibrium

An economy that operates above its full employment equilibrium is producing goods and services at a higher rate than its potential or long-run average levels as measured by its GDP. The amount that the current real GDP is greater than the historic average is called an inflationary gap, as this accelerates the inflationary pressures in this particular economy.

When the market is in equilibrium, there is no excess supply in the short run. So, everything is in harmony. But an overly active economy creates more demand for goods and services. This increase in demand pushes both prices and wages upward as companies increase production to meet that demand. Companies can ramp up production only so much before hitting capacity constraints. Therefore, increases in supply will be finite.

Economists see this as a cautionary period as it results in a situation where too much money chases too few goods. This creates inflationary pressures in the economy—something that isn’t sustainable for long periods.

Over time, the economy and employment markets will shift back into equilibrium as higher prices bring demand back down to normal run-rate levels.

Above Full Employment Equilibrium vs. Below Full Employment Equilibrium

Below full employment equilibrium is the opposite of above full employment equilibrium. This term is used to describe a situation where an economy's short-run real GDP is lower than its long-run potential real GDP. In this case, the difference between the two levels of GDP is referred to as a recessionary gap.

Economies with below full employment equilibrium run with an employment shortfall, and are usually at the risk of running into a recession.

Special Considerations

When an economy is at full employment, all available labor is being utilized. This level varies by economy and can change over time, so it isn't a static situation.

A number of factors can cause employment to rise beyond its equilibrium level. A significant increase in demand—also called a positive demand shock—is one example. This is caused by an unexpected event such as a natural disaster or technological advances.

Other factors include, but aren't limited to, government spending or government stimulus packages. 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 the government are known as expansionary fiscal policy.

An increase in the demand for a country’s goods and services as well as an increase in household consumption can cause an inflationary gap. Policies such as increasing taxes, reducing spending, and/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.