The amount by which the equilibrium level of real GDP exceeds the full employment level of GDP is called

Correct — B, inflationary gap. Full employment sets a ceiling on what an economy can produce with the labour and capital it has. When aggregate demand pushes the equilibrium level of real output above that full-employment level, the extra demand cannot be met with extra goods, so it spends itself on prices instead — hence the name. The measure of the excess is the inflationary gap. Keynes introduced the term in How to Pay for the War in 1940 to describe wartime demand outrunning capacity, and the policy response is contractionary: raise taxes, cut public spending, tighten money.

• (a)recessionary gap — The mirror image. A recessionary or deflationary gap is the amount by which equilibrium output falls short of the full-employment level, and it shows up as unemployment rather than as rising prices.
• (c)income multiplier — The multiplier is a ratio, not a gap — it measures how much total income changes for a given change in autonomous spending, and equals 1/(1 − marginal propensity to consume).
• (d)automatic stabilizer — A feature of the fiscal system, not a quantity of output. Progressive income tax and unemployment benefit damp the cycle without any fresh decision by government, which is what makes them automatic.

Keynesian macroeconomics compares two things: the equilibrium level of output that aggregate demand actually produces, and the full-employment level the economy is capable of. The difference between them is a gap, named for what it causes. Above capacity the gap is inflationary; below capacity it is recessionary. Closing either one is the classic case for discretionary fiscal policy.

The two remaining options belong to the same chapter, which is what makes them tempting. The multiplier tells you how large a change in government spending is needed to close a gap of a given size — a gap of 100 with a multiplier of 4 needs an injection of 25. Automatic stabilisers are what close part of the gap without anyone acting: in a boom, rising incomes push people into higher tax brackets and benefit payments fall, both of which drain demand. Keeping a gap, a ratio and a mechanism in separate mental boxes is the whole task here.

• Inflationary gap = equilibrium real GDP minus full-employment real GDP, when the first exceeds the second.
• Recessionary or deflationary gap = the shortfall in the opposite case.
• The multiplier equals 1/(1 − marginal propensity to consume), or 1 divided by the marginal propensity to save.
• Automatic stabilisers include progressive income tax and unemployment benefits, which work without fresh policy decisions.
• The term inflationary gap comes from Keynes's 1940 pamphlet How to Pay for the War.

• Swapping the two gaps; the inflationary one sits above the full-employment level.
• Treating full employment as the maximum conceivable output rather than the sustainable one.
• Choosing the multiplier because it appears in the same diagram.

A one-line definition item. Papers alternate between asking for the excess and asking for the shortfall, so learn the pair together.

• practice — not a real PYQ

  If the marginal propensity to consume is 0·8, the value of the multiplier is

  • (a)2
  • (b)4
  • (c)5
  • (d)8

  Answer(c) 5 — the multiplier is 1/(1 − 0·8) = 1/0·2.

• practice — not a real PYQ

  Which one of the following acts as an automatic stabiliser in an economy?

  • (a)A change in the repo rate
  • (b)Progressive income tax
  • (c)A new capital expenditure programme
  • (d)Disinvestment of a public sector unit

  Answer(b) Progressive income tax — the yield rises in a boom and falls in a slump without any fresh decision.