Explain concept of deflationary gap

Explain the concept of deflationary gap. Also explain the role of margin requirement in reducing it.

When there is involuntary unemployment in the economy, there is a short fall in Aggregate Demand from the level that is required to maintain a full employment equilibrium. This short fall is termed as deflationary gap.

In this figure, {{AD}_{FE}} = AD at full employment level
{{AD}_{IU}} = AD at involuntary unemployment level The point E is the equilibrium point, where AD = AS. But at the current deficient demand situation (due to involuntary unemployment) of
{{AD}_{IU}}, the Aggregate Demand FP is less than the actual supply EP in the economy. Hence, EF is the deflationary gap.
Deflationary Gap
= Deficient Demand = {{AD}_{FE}} -
{{AD}_{IU}} = EF
Role of margin requirements to reduce deflationary gap Margin requirement refers to the difference between the amount of loan granted and the current value of security offered for loans. In case of deflationary gap, the margin requirements are lower to increase the flow of credit by encouraging people to borrow. As a result of that, the Aggregate Demand increases and ultimately, the economy attains equilibrium.