Explain the following:
Meaning of an excess of demand.
or
Explain the concept of inflationary gap with the help of diagram.
or
Draw a diagram showing inflationary gap.

Meaning of an excess demand.

When in an economy, aggregate demand is in excess of 'aggregate supply at full employment', the demand is said to be an excess demand and the gap is called inflationary gap. In other words, excess demand refers to the excess of aggregate demand over the available output (aggregate supply) at full employment. The gap is called inflationary because it causes inflation (continuous rise in prices) in the economy.
Inflationary Gap. When aggregate demand is more than 'level of output at full employment' then the excess or gap is called inflationary gap. Alternatively, it is the amount by which actual aggregate demand exceeds the level of aggregate demand required to establish full employment equilibrium. Thus inflationary gap is a measure of amount of the excess of aggregate demand over 'aggregate supply at full employment'. It indicates that the buyers intend to buy more than the maximum physical output the producers can produce by employing all the available resources. In such a situation an increase in demand means only an increase in money expenditure without any corresponding increase in output and employment because all the resources have already been fully employed. A simple example will further clarify it. Let us suppose that an imaginary economy by employing all its available resources can produce 10,000 qtls. of rice. If actual aggregate demand for rice is, say 12,000 qtls., this demand will be called an excess demand, because output (aggregate supply) at level of full employment of resources is only 10,000 qtls. As a result the excess of 2,000 (=12,000 - 10,000) qtls. will be called an inflationary gap.
This situation is depicted in Fig.(a). Here point E lying on 45° line is the full employment equilibrium point. This is an ideal situation because aggregate demand represented by EM is equal

Fig.(a)

to full employment level of output (aggregate supply) represented by OM. Suppose the actual aggregate demand is for a level of output BM which is greater than full employment level of output EM (OM). Thus the difference between the two is EB (BM – EM) which is measure of inflationary gap or excess demand.
In short, inflationary gap is the amount by which aggregate demand exceeds the aggregate demand required to establish the full employment equilibrium.
Impact of Excess Demand. (i) It causes rise in prices. Since there is already full capacity production, excess demand does not cause any rise in output and employment but it leads to rise in prices. In such a situation when resources have been fully employed, increase in demand implies pressure on existing supplies of goods causing rise in prices and a situation of inflation. Clearly, this is demand pull inflation, i.e., demand induced increase in price level. A persisting rise in general level of prices after full employment is called inflation.(ii) It causes inequalities. Inflation creates inequalities of distribution of wealth, loss to creditors and salaried people, social unrest and revolt, loss of faith in government and morality. Remember, in such a situation real income (i.e., in terms of physical output) cannot rise but money income (i.e., in terms of money value of physical output) will rise.