In the context of inflationary gaps, what is the likely impact on unemployment and inflation when the economy operates above its potential output?

When the economy operates above its potential output, it creates what is known as an inflationary gap. This situation means that businesses are producing more goods and services than the economy can sustainably support. As a result, demand for labor increases, which typically leads to lower unemployment because more workers are needed to meet the high demand. However, this increased production can also drive up prices, leading to inflation as businesses raise prices to manage higher costs and demand. For example, if a factory operates at full capacity and hires more workers, it might raise the prices of its products to cover the costs of paying those new employees, resulting in higher inflation alongside lower unemployment.