Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What defines a deflationary gap in an economy?

1. Full utilization of resources

2. An increase in demand leading to higher prices

3. Unemployment of resources with constant prices

4. Excess demand causing price reductions

The correct answer is: Unemployment of resources with constant prices

A deflationary gap occurs in an economy when there is a situation where resources are underutilized while the overall price level remains constant. This typically implies that the actual output of an economy is less than its potential output. When there is unemployment of resources, such as labor or capital, it indicates that the economy is not producing at its full capacity, which can lead to lower overall demand for goods and services. In a deflationary gap, the existing quantity of goods and services does not meet the needs of potential economic growth, often resulting in downward pressure on prices, but not necessarily causing them to decrease at first. This scenario indicates a lack of aggregate demand, where consumers and businesses do not have sufficient confidence to spend, thus leading to higher unemployment and underused resources. The other possibilities do not accurately describe a deflationary gap. Full utilization of resources implies a balanced or inflationary situation where demand meets or exceeds supply. An increase in demand leading to higher prices reflects an inflationary scenario rather than a deflationary one. Lastly, excess demand causing price reductions is contradictory, as excess demand typically leads to price increases rather than decreases. Hence, the definition correctly aligns with the state of resource underemployment while prices remain relatively stable.