Final answer:
In an economy, an inflationary gap occurs when there is a continuous increase in aggregate demand (AD) beyond full employment and potential GDP. This results in a higher price level and a shift in the AD-AS model. The graph shows the rightward shift of AD, leading to an inflationary gap.
Step-by-step explanation:
Inflationary pressures in an economy occur when there is a continuous increase in aggregate demand (AD) when the economy is already operating at or near full employment and potential GDP.
This causes the macroeconomic equilibrium to shift into the steep portion of the aggregate supply (AS) curve, resulting in an inflationary gap. In Figure 25.6, an inflationary gap is depicted as a rightward shift of AD from the initial equilibrium (Eo) to a new equilibrium (E₁) at a higher price level. This reflects an increase in aggregate demand exceeding the economy's capacity to produce.