c) If the full employment income level is RM3,500, is there an inflationary gap or a deflationary gap? Draw a diagram to show the situation.(4 marks)

To answer this question, we first need to understand what an inflationary gap and a deflationary gap are.

1. Inflationary Gap: This occurs when the total spending exceeds the production of goods and services at full employment level. This leads to an increase in the price level (inflation).

2. Deflationary Gap: This occurs when the total spending is less than the production of goods and services at full employment level. This leads to a decrease in the price level (deflation).

Now, to determine whether there is an inflationary gap or a deflationary gap, we need to know the current income level. If the current income level is more than RM3,500, there is an inflationary gap. If it is less than RM3,500, there is a deflationary gap.

Unfortunately, without this information, we cannot definitively say whether there is an inflationary gap or a deflationary gap.

As for the diagram, it would typically look like this:

• The vertical axis represents the price level.
• The horizontal axis represents the national income.
• The upward sloping line represents the aggregate supply.
• The downward sloping line represents the aggregate demand.
• The point where these two lines intersect is the equilibrium point, which represents the full employment income level.

If the equilibrium point is to the right of the full employment income level, this indicates an inflationary gap. If it is to the left, this indicates a deflationary gap.