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20_EXCESS DEMAND AND DEFICIENT DEMAND

 

 

 

 

ECONOMICS (CLASS-XII)

 

Chapter-20

EXCESS DEMAND AND DEFICIENT DEMAND

 

 

 

Full Employment:

            Itis a situation where every able person who is willing to work at a given wage rate finds a job. It implies the absence of involuntary unemployment.

Involuntary Unemployment:

            It is a situation where people who are able and willing to work do not get a job at a given wage rate.

Full Employment Equilibrium :

            When AD equals AS such that resources are fully employed, the economy achieves full employment equilibrium.

Efficient Demand :

            The levels of AD required to achieve full employment equilibrium is called efficient demand or AD at the point of full employment equilibrium is called efficient demand.

 

DEFICIENT DEMAND

 

Deficient demand is defined as a situation when the AD in an economy leads to an amount of income which is less than the full employment level of income. It gives rise to a deflationary gap. As a result, the resources in the economy remain unutilized indicating under employment.

 

 

Deflationary Gap

It measure the extent to which the current AD falls short of the AD required to achieve full employment equilibrium.

 

In the Fig. E is the full employment equilibrium. Suppose the actual level of demand (By1) is less than the aggregate demand at full employment level (Ey2). The difference between the two is deflationary gap.

Reasons of Deficient Demand

(1)        Reduction in government expenditure i.e. surplus of govt, revenue over its expenditure leads           to deficient demand.

(2)        A fall in autonomous investment.

(3)        A fall in the level of consumption due to rise in propensity to save.

(4)        Fall in the supply of money in the economy.

Impact of Deficient Demand

(1)        The general impact of deficient demand is reduction in employment income and price          levels.

(2)        It leads to overproduction and idleness of resources.

(3)        It adversely affects production activities.

Measures to Improve Deficient Demand

(I)        Fiscal Policy : It is the policy relating to government revenue and expenditure in the budget. In order to increase aggregate expenditure, government can adopt following measures.

(a)        Decrease in taxes : Direct tax and indirect tax, should be reduced. This will increase the disposable income in the hands of people, who have more to spend on consumption.

(b)        Increase in public expenditure : In case of deficient demand, the government should increase the public expenditure, like construction of roads, bridges, buildings, etc. In this way, more money will flow into the hands & thereby they will spend more.

(c)        Deficit financing: The printing of new currency notes should be encouraged so that more money flow into the economy and demand level rises.

(d)        Public borrowing : Public borrowing should be discouraged by the government in the situation of deficient demand. Although it may lead to budget deficit but it may fill up the deflationary gap.

(II)       Monetary Policy : It is the policy adopted to control the availability of credit and supply of money in an economy.

(a)         Bank rate : In the situation of deficient demand, the central bank reduces I the bank rate and increases the availability of credit which will ultimately leads to rise in aggregate expenditure.

(b)         Open market operation: In order to expand credit, central bank purchases securities in the open market. The sellers are usually the commercial bank or their customer. The payments are made by the central bank. This will increase the quantity of money circulation which ultimately leads to increase in aggregate expenditure.

(c)         Cash reserve Ratio : The fixed percentage of total deposits of banks needs to be kept as cash with the central bank which is known as CRR. The reduction in the cash reserve ratio releases money. This gives bank more money in their hands to lend to firms. Thus money supply and aggregate exp. Increases.

(d)         Moral suasion : The central bank makes oral or written appeal to the commercial bank to change the money supply in the economy. In case of deficient demand, banks are persuaded to increase the lending.

(e)        Margin requirement: Margin requirement refers to the difference between the value of the security and the amount of loan. To correct the situation ofdeficient demand, margin requirement is reduced to encourage borrowings.

EXCESS DEMAND

When the planned aggregate expenditure is greater than the available output at full employment level, the situation is termed as excess demand. It leads to inflationary gap in the economy.

Inflationary Gap

When aggregate demand is more than the level of output at the full employment level, then the gap is called inflationary gap.

In the fig. point E is the full employment equilibrium. At this point, AD is EY. Suppose the actual AD is more than the full employment level of output i.e. BYl. The difference between the two is inflationary gap or excess demand.

Reasons of Excess Demand

(1)        It can be caused due to increase in money supply due to deficit financing.

(2)        It can be caused due to increase in consumption demand due to rise in propensity to consume.

(3)        An increase in autonomous investment without the corresponding increase in savings may cause excess demand.

(4)        It can also be caused due to increase in demand for exports.

Impact of Excess Demand

(1)        Excess demand causes prices to rise.

(2)        Excess demand will bring no. increase in output since full employment level of income has already being achieved.

Measure to Control Excess Demand

(I)        Fiscal Policy : It is the policy relating to govt. revenue and expenditure andbudget. In order to decrease aggregate expenditure.The government can adopt followingmeasures:

(a)        Increase in taxes : The rate of direct and indirect tax should be increased. This will decrease the disposable income in the hands of people, who have less to spend on consumption.

(b)        Decrease in public exp.: In case of excess demand, the govt. should decease the public expenditure on construction of roads, bridges, buildings, etc. In this way, less money will flow into the economy and thereby, less expenditure will take place.

(c)        Deficit financing: Printing of new currency notes should be cut down as it reduces the government ability to spend which in turn will decrease AD in the economy.

(d)        Public borrowing : The government should go for large scale public borrowing to reduce the excess money with the people.

(II)       Monetary Policy : It is the policy adopted to control the availability of creditand supply of money into the economy.

(a)        Bank rate : In the case of excess demand, the central bank increases the bank rate and decreases the availability of credit, which will ultimately lead to fall in aggregate expenditure.

(b)        Open market operation : In order to restrict credit, central bank sells the securities in the open market. The purchasers are usually the commercial bank or its customers. The payment is collected by central bank. This will decrease the quantity of money circulation which ultimately leads to decrease in aggregate expenditure.

(c)        Cash reserve ratio : The fixed percentage of total deposits of the bank needs to be kept as cash with central bank which is known as cash reserve ratio. The increase in CRR restricts money. This gives bank less money in their hands to lend. Thus money supply and aggregate expenditure decreases.

(d)        Moral suasion : The central bank makes oral and written appeal to the commercial bank to change the money supply in the economy. In case of excess demand, banks are persuaded to decrease the lending.

(e)        Margin requirement: Margin requirement refers to the difference between the value of the security and the amount of loan. To correct the situation of excess demand, margins are increased to discourage borrowings.

 

 

 

 

 

 

 

 

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