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Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.
Updated January 09, 2024 Reviewed by Reviewed by Robert C. KellyRobert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital.
When an economy is at full employment, all available labor is utilized. Many factors can cause employment to rise beyond this equilibrium level. Above full employment equilibrium is a macroeconomic term describing an economy’s gross domestic product (GDP) as higher than average, exceeding its long-run potential level, and causing inflationary pressure.
When the market is in equilibrium, there is no excess supply in the short run. An overly active economy creates more demand for goods and services. The increase in demand pushes both prices and wages upward as companies increase production to meet that demand.
An economy that operates above its full employment equilibrium produces goods and services at a higher rate than its potential or long-run average levels as measured by GDP. The amount that the current real GDP is greater than the average is called an inflationary gap, which accelerates inflationary pressures in the economy.
Economists view this situation as too much money chasing too few goods. Over time, the economy and employment markets will move to equilibrium as higher prices decrease demand to normal run-rate levels.
An economy that runs above full employment equilibrium may lead to inflation.
Below full employment equilibrium is the opposite of above full employment equilibrium, and an economy's short-run real GDP is lower than its long-run potential real GDP. In this case, the difference between the two levels of GDP is referred to as a recessionary gap. Economies with below full employment equilibrium run with an employment shortfall and are usually at risk of running into a recession.
At full employment, all labor is used. Factors that may cause employment to rise beyond its equilibrium level include:
Policies such as increasing taxes, reducing spending, or increasing the level of interest rates can be used to bring an overheating economy back into equilibrium.
An increase in the demand for a country’s goods and services and an increase in household consumption can cause an inflationary gap.
Rising prices coupled with a decline in purchasing power signal a period of inflation. The rate at which purchasing power drops can be reflected in the average price increase of a basket of selected goods and services over time. The rising prices mean that a currency unit effectively buys less than it did in prior periods.
Above full employment equilibrium is when an economy’s gross domestic product (GDP) is above average and exceeds its long-run potential level. An economy is at risk of inflation as more demand for goods and services increases prices and wages, causing companies to raise production to meet demand.
Related TermsAn economic depression is a steep and sustained drop in economic activity featuring high unemployment and negative GDP growth.
Net national product (NNP) is the total value of finished goods and services produced by a country's citizens overseas and domestically, minus depreciation.
The poverty gap reflects the intensity of poverty in a nation, showing the average monetary shortfall of the total population from the official poverty line.
Dollarization takes place when the U.S. dollar is used along with or instead of a country's domestic currency.
The Consumer Confidence Index (CCI) is a survey that measures how optimistic or pessimistic consumers are regarding their expected financial situation.
The ZEW Indicator of Economic Sentiment aggregates the sentiments of about 350 economists and analysts regarding Germany's short-term economic future.
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