A deflationary gap (also known as a recessionary gap) occurs when an economy’s actual national income is lower than its full employment level. This means the economy is producing less than its total sustainable capacity, leaving resources unused.

Key features of a deflationary gap:

• It is a negative output gap, meaning actual output is less than the potential output required for full employment.
• It signals spare capacity within the economy, such as high unemployment and idle machinery.
• Because there are unused resources, an increase in production does not necessarily lead to higher prices or inflation.
• On an AD-AS diagram, it is represented by the horizontal distance between the current equilibrium and the full employment output level.
• To fix this, governments often use expansionary fiscal policy, such as increasing government spending or cutting taxes, to boost demand.
• The multiplier effect ensures that government spending can significantly increase total national income.
• This concept supports the theory that government intervention is often needed during a recession because markets do not always self-correct quickly.
• The gap can persist because wages and prices are often sticky downward, meaning they do not drop fast enough to restore full employment on their own.