Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What occurs during an inflationary gap?

1. Resources are underutilized

2. Prices remain constant

3. Resources are fully employed and demand increases

4. The economy is in a recession

The correct answer is: Resources are fully employed and demand increases

During an inflationary gap, the economy experiences a situation where aggregate demand exceeds the economy’s potential output at full employment. This means that resources, including labor and capital, are fully employed, and there is pressure on prices to rise due to increased demand. When demand increases significantly, businesses may struggle to meet this heightened demand, leading to a situation where they are operating at or above their capacity. This often results in rising prices as companies attempt to capitalize on the higher demand and cover increasing production costs. Therefore, the core characteristic of an inflationary gap is that resources are fully employed and demand is increasing, setting off inflationary pressures in the economy. In this context, the escalation of demand drives prices up, indicating robust economic activity that can lead to inflation if sustained. The other options do not accurately describe the situation during an inflationary gap. Resources being underutilized relates to an economic downturn, while prices remaining constant contradicts the very notion of increased demand leading to inflation. Lastly, stating that the economy is in a recession would be a direct contrast to the conditions of an inflationary gap, where the economy is actually overheating.