DEFICIENT DEMAND

Deficient demand refers to a situation when aggregate demand is short of aggregate supply corresponding to full employment in the economy i.e. AD <AS.
The situation of deficient demand arises when planned aggregate expenditure falls short of aggregate supply at the full employment level. It gives rise to deflationary gap. Deflationary gap is the shortfall in aggregate demand from the level of aggregate supply required to maintain the level of full employment equilibrium.

Reasons for Deficient Demand

1)      Decrease in Propensity to consume - A decrease in consumption expenditure, due to fall in the propensity to consume, leads to deficient demand in the economy.

2)      Increase in taxes - AD may also fall due to imposition of higher taxes. It leads to decrease in disposable income and, as a result, the economy suffers from deficient demand.

3)      Decrease in Government Expenditure - When government reduces its demand for goods and services due to fall in public expenditure, it leads to deficient demand.

4)      Fall in Investment expenditure - Increase in the rate of interest or fall in the expected returns lead to decrease in the investment expenditure. It reduces the AD and gives rise to deficient demand.

5)      Rise in Imports- When international prices are comparatively less than the domestic prices, then it may lead to a rise in imports, implying a cut in the aggregate demand.

6)      Fall in Exports - Exports may fall due to comparatively higher prices of domestic goods or due to increase in the exchange rate for domestic currency. This will lead to deficient demand.

Consequences of Deficient Demand
1)      Impact on employment- If aggregate demand is less than aggregate supply, entire amount of goods produced in an economy is not sold. This leads to over production. Therefore, producers reduce production resulting in unemployment.
2)      Impacts on Output - When aggregate demand is less than aggregate supply, producers are not able to sell the entire output produced in the economy during a given period. Therefore, they reduce the volume of production of output. Thus, deficient demand is responsible for low output in an economy.
3)      Impact on Price Level- When aggregate demand is less than aggregate supply, price level tends to fall. Unless deflationary gap is removed, price level continues to decline. Decline in price level leads to fall in the rate of profit. Continuous fall in rate of profit leads to a decline in the volume of private investment.


EXCESS DEMAND
Excess Demand refers to the situation when aggregate demand is in excess of aggregate supply corresponding to full employment in the economy i.e. AD > AS.

Reasons for Excess Demand

1)      Rise in the Propensity to consume - Excess demand may arise because of increase in consumption expenditure due to rise in the propensity to consume or fall in propensity to save.

2)      Reduction in taxes - It may also occur due to increase in disposable income and consumption demand because of decrease in taxes.

3)      Increase in Government Expenditure - Rise in government demand for goods and services due to increase in public expenditure will also result in excess demand.

4)      Increase in Investment - Excess demand can also arise when there is increase in investment due to decrease in rate of interest or increase in expected returns.

5)      Fall in Imports - Decrease in imports due to higher international prices in comparison to domestic prices may also lead to excess demand.
6)      Rise in Exports - Excess demand may also arise when demand for exports increases due to comparatively lower prices of domestic goods or due to decrease in the exchange rate for domestic currency.

7)      Deficit Financing - Excess demand may be caused due to increase in the money supply caused by deficit financing.

Consequences of Excess Demand

1)      Effect on Output - Excess demand does not affect the level of output because economy is already at full employment level and there is no idle capacity in the economy.

2)      Effect on Employment - There will be no change in the level of employment as the economy is already operating at full employment equilibrium and there is no involuntary unemployment.

3)      Effect on General Price Level - Excess demand leads to rise in the general price level (known as inflation) as aggregate demand is more than aggregate supply.


Measures to Correct Deficient and Excess Demand

1)      Fiscal Policy
2)      Monetary Policy
3)      Foreign Trade Policy

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