Chapter 9 Excess Demand And Deficient Demand
Excess Demand / Inflationary Gap / Over employment Equilibrium
Excess Demand: It is the situation in which AD is for an output which is above full employment AD.
Inflationary Gap: It is the gap showing excess of AD above full employment AD.
Diagram:
Effects of Excess Demand
(1). It causes a continuous & persistent rise in price.
(2). The producer gets abnormal profits margin.
(3). The consumers are losses as their purchasing power goes down with rise in prices.
(4). It results in a wage-price spiral i.e rise in prices implies that real wages will fall. So, the union will demand for higher wages. It will increase the cost of production & It will again lead to rise in prices.
(5). It will lead to increase in employment. But generally there is no change in unemployment because the system is in full employment.
(6). If there is full employment in the economy, production cannot be increased. But if the resources are not fully employed, then they will be fully employed & production will increases.
(7). It leads to prosperity or boom conditions in the trade cycle of an economy.
Deficient Demand / Deflationary Gap / Under employment equilibrium
Deficient Demand: It is a situation in which AD is for an output which is below full employment AD.Deflationary Gap: It is a gap showing deficiency of AD below full employment AD.Diagram:
Effects of Deficient Demand
(1). There is a fall in the general price level.
(2). The producer incur losses or their profits are nil.There is a fall in the level of production are there are unsold stock of goods.
(3). Consumers are gainers because prices have gone down.
(4). Fall in the level of national income.
(5). Fall in the level of employment which leads to strikes & lockouts.
(6). It there is oligopoly, the price will remain same but level of production will decline.
(7). It will lead to recession & depression in the trade cycle of an economy.
Measures to Control Excess Demand / Inflationary Gap/ Over employment equilibrium
Fiscal Policy OR Budgetary Policy
Meaning: It is the revenue & Expenditure policy formulated by government to combat inflation and deflation.
(1). Revenue Policy: During inflation government increases its revenue by increasing the taxes to reduce flow of excessive money in economy.
(2). Expenditure Policy: Government reduces its expenditure on public works like roadways, Dams, bridges etc , So that supply of money does not increase in the economy.
(3). Public Borrowings: Government by issuing bonds and other securities should borrow money from public. It reduce the excessive flow of money in the economy.
(4). Deficit Financing: Government should cu down on printing of new currency notes, as there is already excessive money flowing in the economy.
Quantitative & Qualitative Measures
1. Bank Rate: It refers to the rate at which central Bank lends money to commercial banks to meet their long-terms needs.
At the time of inflation: When there is excessive flow of money in the economy, RBI increases the bank rate which makes loans costlier & flow of money in the economy is reduced.
At the time of Deflation: When the money flow in economy is less, bank rate is reduced loans become cheaper & the flow of money is boosted.
2. Repo Rate: It is rate at which the central bank lends money to commercial banks to meet their short-terms needs.
At the time of Inflation: An increase in repo rate increase the cost of borrowings from the central bank. It forces the commercial banks to increase their lending rate, which discourages borrowers from taking loans. It reduces the ability of commercial banks create credit.
At the time of Deflation: Decrease in repo rate, decrease the cost of borrowings from the central bank. It forces the commercial banks to decrease their lending rate, which encourages borrowers from taking loans. It increase the ability of commercial banks create credit.
3. Legal Reserve Requirements: Banks are obliged to maintain reserves with the central bank on two accounts:
(a). Cash Reserve Ratio: It refers to the Minimum % of net demand and time liabilities, to be kept by commercial banks with central banks.
At the time of Inflation: An increase in CRR as the effect of reducing the banks excess reserves and thus curtail their ability to give to give credit.
At the time of Deflation: An decrease in CRR as the effect of increasing the banks excess reserves and thus it increase their ability to give credit.
(b). Statutory Liquidity Ratio (SLR): It refers to the minimum % of net demand and time liabilities which central banks are required to maintain with themselves.
At the time of Inflation: This effects their freedom to increase the quantum of credit and therefore the money supply increasing the SLR reduces the ability banks to give credit.
At the time of Deflation: This effects their freedom to decreases the quantum of credit and therefore the money supply decreases the SLR increases the ability banks to give credit.
4. Open Market Operation: refers to buying and selling of government securities by the central banks from to the public and commercial banks.
At the time of inflation: RBI sells securities to commercial banks & general public so that it can reduce the excessive flow of money.
At the time of Deflation: RBI buys these securities & gives money to the people & banks.
5. Margin Requirement: Refers to the difference between the loan value & market value.
At the time of Inflation: This margin is increased so that people can be discouraged from taking loans.
At the time of Deflation: This margin is reduced so that people are encouraged to take loans.
Measures To Control Deficient Demand / deflationary Gap / under employment equilibrium
Fiscal Policy Or Budgetary Policy
Meaning: It is the revenue & Expenditure policy formulated by government to combat inflation and deflation.(1). Revenue Policy: During deflation government decreases its revenue by decreasing the taxes to increase flow of excessive money in economy.(2). Expenditure Policy: Government increases its expenditure on public works like roadways, Dams, bridges etc , So that supply of money increase in the economy.(3). Public Borrowings: Government by purchase bonds and other securities from public. It increase the flow of money in the economy.(4). Deficit Financing: Government printing of new currency notes, as there is an increase in money flowing in the economy.
Quantitative & Qualitative Measures
Diagram:
Effects of Excess Demand
(1). It causes a continuous & persistent rise in price.
(2). The producer gets abnormal profits margin.
(3). The consumers are losses as their purchasing power goes down with rise in prices.
(4). It results in a wage-price spiral i.e rise in prices implies that real wages will fall. So, the union will demand for higher wages. It will increase the cost of production & It will again lead to rise in prices.
(5). It will lead to increase in employment. But generally there is no change in unemployment because the system is in full employment.
(6). If there is full employment in the economy, production cannot be increased. But if the resources are not fully employed, then they will be fully employed & production will increases.
(7). It leads to prosperity or boom conditions in the trade cycle of an economy.
Deficient Demand / Deflationary Gap / Under employment equilibrium
Deficient Demand: It is a situation in which AD is for an output which is below full employment AD.Deflationary Gap: It is a gap showing deficiency of AD below full employment AD.Diagram:
Effects of Deficient Demand
(1). There is a fall in the general price level.
(2). The producer incur losses or their profits are nil.There is a fall in the level of production are there are unsold stock of goods.
(3). Consumers are gainers because prices have gone down.
(4). Fall in the level of national income.
(5). Fall in the level of employment which leads to strikes & lockouts.
(6). It there is oligopoly, the price will remain same but level of production will decline.
(7). It will lead to recession & depression in the trade cycle of an economy.
Measures to Control Excess Demand / Inflationary Gap/ Over employment equilibrium
Fiscal Policy OR Budgetary PolicyMeaning: It is the revenue & Expenditure policy formulated by government to combat inflation and deflation.
(2). Expenditure Policy: Government reduces its expenditure on public works like roadways, Dams, bridges etc , So that supply of money does not increase in the economy.
(3). Public Borrowings: Government by issuing bonds and other securities should borrow money from public. It reduce the excessive flow of money in the economy.
(4). Deficit Financing: Government should cu down on printing of new currency notes, as there is already excessive money flowing in the economy.
Quantitative & Qualitative Measures
Fiscal Policy Or Budgetary Policy
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