Deficient Demand and Excess Demand

ntroduction Before 1930’s, classical school of thought prevailed which advocates that aggregate demand is always equal to aggregate supply in an economy. There is always full employment in an economy. Under classical model, supply creates its own demand, excess supply in one market is automatically balanced with excess demand in another; there can be no such thing as economy-wide Excess supply or Excess Demand. In 1930’s during The Great Depression, the situation emerged where aggregate demand did not meet the aggregate supply. It was Prof. John Maynard Keynes who introduced the concept of “Deficient Demand” and “Excess Demand” even at full employment level and the role of government in correcting the situation of excess demand and deficient demand. Deficient Demand is a situation in which aggregate demand (AD) is short of aggregate supply (AS) corresponding to full employment in an economy. It points towards the situation of deflation in an economy. Excess Demand is a situation when aggregate demand (AD) is in excess of aggregate supply (AS) corresponding to full employment in the economy. It points towards the inflationary situation in an economy. Deflationary gap is the measure of the amount of deficiency of aggregate demand in the economy. Inflationary gap is the measure of the amount of excess of aggregate demand in the economy.

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  • Q1

    How does a trade cycle occur?

    Marks:2
    Answer:

    A trade cycle occurs due to fluctuations that an economy experiences over time. These fluctuations primarily result from changes in the aggregate demand.

    Trade cycle can also be defined as the ups and downs of business activities.

    It is shown as below:

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  • Q2

    What are the main causes of deficient demand in an economy?

    Marks:2
    Answer:

    The various causes of deficient demand are:
    1. Reduction in private consumption expenditure

    2. Reduction in investment expenditure
    3. Decline in exports / Rise in imports
    4. Increase in tax rates

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  • Q3

    Define inflation.

    Marks:1
    Answer:

    Inflation is a process of persistent and considerable increase in the general level of price in an economy.

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  • Q4

    What do you mean by deficient demand.

    Marks:1
    Answer:

    Deficient demand is a situation in which aggregate demand (AD) is less than the aggregate supply (AS) corresponding to full employment in the economy.

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  • Q5

    Define excess demand.

    Marks:1
    Answer:

    Excess demand is a situation when aggregate demand (AD) is greater than the aggregate supply (AS) corresponding to full employment in the economy.

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