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What Is an Expansionary Gap?

Esther Ejim
Esther Ejim

An expansionary gap is an economic term that refers to the difference between the real Gross Domestic Product (GDP) and the potential GDP in a given economy. The expansionary gap is one that is determined by output since the difference between the real and potential GDP lies in the fact that the real GDP has been adjusted to compensate for inflationary factors, while the potential GDP is a representation of the real GDP in times when there is full employment in a stated economy. As such, where the situation in the country is such that the potential GDP output is less than the actual GDP output, the economy would be said to have an expansionary gap.

Something that is worth considering when analyzing the occurrence of an expansionary gap within the economy of a country is the source of such a gap. Usually, the gap may be the consequence of the application of a monetary policy by the central or chief bank in that region. Such monetary policies often include the reduction of interest rates as a means of encouraging more consumption by consumers in cases where the objective is to stimulate a lackluster or underperforming economy. This reduction of interest often means that consumers will be able to gain easier access to funds and credit facilities with which to facilitate their purchases and other expenditures. An increase in consumption will inevitably lead to a spike in the level of demand for various goods and services in the economy, putting a strain on the ability of the producers, manufacturers and suppliers to meet the demand.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

The expansionary gap occurs as a sort of response to the excess of demand in relation to the availability of supply, something that may also be referred to as the demand-pull inflation. In the determination of an expansionary gap, projections are usually made into the future as a means of determining a situation where the expenditure will not be at par with the consumption. An illustration of the concept of an expansionary gap can be seen in a situation where a company has to pay its employers more due to the increase in demand that forces the company to hire more workers, increase the hours of existing workers, and consequently increase the company’s expenditure on salaries and other wages. Such a factor will cause the company to look for other means of recouping these expenditures, usually in the form of price increases that consequently leads to inflation.

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