Full employment refers to a situation in which every able bodied person who is willing to work at the prevailing rate of wages is, in fact, employed.

Excess demand or Inflationary gap : When in an economy, aggregate demand is in excess of aggregate supply at full employment, the situation is termed as excess demand and the gap created is called inflationary gap.

For example : Lets suppose an imaginary economy, where by employing all of its available resources, it can produce 10,000 quintals of rice. If aggregate demand for rice is, say 12,000 quintals, this demand will be called as excess demand and the gap between demand & supply is called inflationary gap.

The situation is shown through a graph: In the graph, Point E lying on the 45∘ line is the full equilibrium point. This is an ideal situation because aggregate demand represented by EM is equal to full employment level of output represented by OM. The actual aggregate demand is for a level of output BM which is greater than full employment level of output EM (OM). Thus, the difference between the two is EB=(BM−EM) which is measure of inflationary gap.