| Inflationary Gap | Deflationary gap |
| AD > AS at full employment | AD < AS at full employment |
| Aggregate Demand Increases – Supply falls short of demand | Aggregate demand falls – situation of over production |
| Price rises, so investors are motivated to invest | Price falls – depressing environment for investors |
| production, income & employment increases | production, income & employment falls |
Two measures to correct it
Fiscal policy measures;
(i) Public Expenditure:- Government reduces public expenditure at the time of inflation , so that excess purchasing power of people can be reduced & thus excess demand can be curtailed. During deflation government incurs more expenditure so that people have extra money to increase AD.
(ii) Policy of direct taxes: Government increases direct taxes to reduce extra purchasing power of the people to control inflation & reduces direct taxes to provide extra money to people during deflation.
