What is the term for the situation in which the equilibrium level of output is less than the full employment level, resulting in unemployment?

The term that describes a situation where the equilibrium level of output is less than the full employment level, leading to unemployment, is known as a deflationary gap. In this context, a deflationary gap occurs when there is insufficient aggregate demand in the economy to sustain full employment levels of output. Consequently, this shortfall results in unused resources, including labor, which manifests as unemployment.

When the economy operates below its full employment level, it indicates that the potential output, which represents the maximum sustainable level of production that can be achieved without triggering inflation, is not being met. This situation is typically associated with insufficient demand for goods and services, causing producers to limit their output and leading to higher unemployment levels as firms require fewer workers.

Understanding the concept of a deflationary gap is crucial for economic policy, as it helps to identify the need for government or central bank intervention, such as fiscal stimulus or monetary easing, to boost aggregate demand and move the economy closer to full employment.