Economics Ch - 9 Class 12th (Problem of Deficient Demand and Excess Demand)

Ch - 9(Problem of Deficient Demand and Excess Demand)

Full Employment Equipment - It refers to a situation when AS = AD along with fuller utilization of resources.

Underemployment Equilibrium - It refers to that situation in the economy when AS = AD but without fuller utilization of resources. 

Voluntary Unemployment - It refers to a situation when some people are not willing to work at existing wage rate.

Involuntary Unemployment - It refers to a situation when some people are not getting even when they are willing to work at existing wage rate.

Full Employment - It refers to a situation in which all those who are able to work and are willing to work at existing wage rate are getting work.but it does not mean a situation of zero unemployment. 

There are always exists some degree of unemployment called Natural Unemployment*.

Natural Rate of Unemployment is the minimum rate of unemployment that must exist in the economy even when labour market is in a state of equilibrium.

1.) Frictional Unemployment - It is the unemployment associated with changes related to shifting from one job to the other.

2.) Structural Unemployment - It is the Unemployment associated with structural changes in the economy like change in technology. 

                   Problem of Deficient Demand 

Deficient Demand occurs when AD < AS corresponding to Full Employment in Economy.

It Implies - 

1. AD is short of its Full employment level.

2. AD is perfectly elastic till then it reach at full employment level. 

Explanation -

1.) ADፑ line shows the required level of AD for Full employment in economy.

2.) ADu line shows that AD at underemployment level.

3.) The vertical difference between ADፑ and ADu is Deflationary Gap.

Causes of Deficient AD - 

1.) Reduction in Private Consumption Expenditure(C).

2.) Reduction in Private Investment Expenditure(I).

3.) Reduction in Government Expenditure(G).

4.) Decline in Export)X).

5.) Rise in Import(I).

6.) Increase in Tax Ratio.

Consequences of Deficient Demand -

1.) Underemployment Equilibrium - Deficient demand leads to underemployment equilibrium owing to deficiency of AD. Producers are not able to fully utilize their resources. Planned output remains less than the potential output. Accordingly Underemployment equilibrium is struck in economy.

2.) Deflationary Gap - It is a situation when lack of demand leads to deflationary pressure in the economy.

Low AD ➝ Low Investment ➝ Low Output ➝ Less Income ➝ Low AD.

This is called Low Level Equilibrium trap .

3.) Undesired Stocks - In a solution of law Ad , Producers are not able to sell all that they plan to sell. According, Undesired stocks tend to fill up.

It leads to:

1.) fall in Prices.

2.) Fall in planned output of year a head.

4.) Loss of Profits - Deficiency of AD cause loss of profits. This happens because:

  a) Producers are not able to clear their stock.

  b) Undesired stocks lead to Price Crash.

                      Problem of Excess Demand

Excess demand occurs when AD > AS corresponding to full employment in economy.

It Implies -

1.) The level of AD surpasses the level of AS even when the available factors are fully utilized.

2.) AS cannot increases after the full employment level.

Explanation -

1.) ADፑ line shows the AD at full employment level.

2.) AD∊ line shows planned AD which is higher than the Full employment AD. 

3.) The vertical difference between ADፑ and AD∊ is called Inflationary Gap.

Cause of Excess AD -

1.) Increase in Private Consumption Expenditure (C).

2.) Increase in Investment Expenditure (I).

3.) Increase in Government Expenditure (G).

4.) Increase in Exports (X).

5.) Decrease in Import (I).

6.) Decrease Tax rates.

Consequences of Excess Demand 

1.) Inflationary Gap - It is excess of AD over and above its level required to maintain employment equilibrium in economy.

Excess AD ➝  Pressure of demand on existing resources ➝  Rise in cost of Production ➝  Rise in general price level ➝ Output level remains constant because resources are already fully employed.

2.) Static GDP - Even when the level of AD is higher than its full Employment level, the level of GDP does not rise. it remains static. It is a situation when higher demand fails to generate higher GDP in economy.

3.) Wage Price Spiral - It is a situation when wages catch prices and prices catch wages. The economy may be driven into a situation of Hyper Inflation.

Excess AD ➝ Pressure of demand on existing resources ➝ Rise in cost of Production ➝ Rise in wages ➝ Rise in general price level ➝ Rise in cost of living ➝ Rise in wages again.

4.) Loss of Profit - Excess demand causes loss of profit. Profit is lost,because the producers are not able to raise their supplies. there is a loss of profit owing to unfulfilled demand in the economy.

Measures to Correct Deficient and Excess Demand -

Fiscal Policy - It refers to the Budgetary policy of Government to correct the situation of excess and deficit demand.

1. Government Expenditure - The govt. spends its revenues for various purposes such as expenditure on public welfare programs, purchase of goods for defense.,etc. 

When Govt. lowers its expenditure it acts as a leakage in economy. This reduces the AD in economy. Thus the Problem of inflation is solved.  

When Govt. raises its expenditure it acts as a injection in economy. This increases the AD in economy. Thus the Problem of deflation is solved.  

2. Taxes - A tax is a compulsory payment by the people of a country to govt. without reference to anything in return.

A Decrease in tax rates, increases the disposable income of people which in turn increases AD and solve the problem of deflation.

A Increase in tax rates, reduces the disposable income of people which in turn decreases AD and solve the problem of inflation.

3. Borrowing from public - By borrowing from public the govt. creates public debts.

In case of deficient demand govt. reduces its borrowing from public so that people are left with greater liquidity of cash. It increases AD and deflationary gap is managed.

When there is a situation of excess demand, the govt. tries to increase public borrowing by offering attractive rate of interest. This reduces liquidity with people, It decreases AD and Inflationary gap is managed.

4. Borrowing from RBI - It is increased to fight deflationary gap and reduced inflationary gap.

Higher borrowing releases greater liquidity in economy as required to correct deflationary gap.

When borrowing is reduces, the amount of liquidity in economy is also reduces as desired to correct Inflationary gap.