question_answer

Distinguish between inflationary gap and deflationary gap. State two measures by which these can be corrected.

Answer:

Deflationary gap: It prevails when aggregate demand is less than aggregate supply at the full employment level of output. In other words, deflationary gap represents the situation of unemployment attributable to the fact that at full employment level of output in the diagram RF is deflationary gap.

Inflationary gap ? This is the situation where economy operates at a level which is greater than full employment.

In other words, the gap between aggregate demand and aggregate supply is known as inflationary gap. In the diagram RN is inflationary gap. Volume of credit should be supervised and controlled for correcting the situation of deflationary and inflationary gap.

Two methods can be adopted for controlling these two gaps:

(i) Open market operations: If the central bank of the country will buy the securities from commercial banks, this will increase the capacity of credit paying of these banks. This way the deflationary situation can be corrected. If the central bank of the country sells the securities in the open market then the situation of inflationary gap will be controlled. Because of this the level of aggregate demand and their credit paying capacity will be reduced.

(ii) Bank Rate: Bank rate should be reduced. This will decline the rate of Interest. This is for controlling deflationary gap. In the case of inflationary gap bank should increase their rate, so that rate of interest will go up and the demand for credit will decline. This will affect aggregate demand.