Demonstrate graphically and explain the case of an inflationary gap.Describe the forces in the economy that will result in the gap closing itself.
The diagram:

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Initially we are in equilibrium with a price level of P1 and real output level of Y1.An inflationary gap of (Y1 - YFE)exists because our current equilibrium level (Y1)is greater than the potential output level (YFE).When this occurs the economy is straining its resources.To be able to produce beyond the potential output level,workers must work overtime and firms get extra workers by bidding them away from other companies.The result is higher wages and increased costs for firms.The increase in wages and costs results in the AS curve shifting up from AS to AS1.

Demonstrate Graphically and Explain the Case of an Inflationary Gap