Excess Demand Class 12 | Deficient Demand | Methods to Correct |

Excess Demand Class 12 | Deficient Demand | Methods to Correct | Chapter 9 | Economics |

Employment/Unemployment and Types

Employment refers to a situation wherein a person works under a contract. Generally, the contract is between two parties for which compensation is received for rendering services whereas unemployment refers to a situation in which one can’t get work or unwilling to work as per his qualification or choice.

Types of Employment

Full Employment: It refers to a situation when there is no excess capacity in an economy or everyone who is capable and willing to work is getting work at the existing work rate in an economy. It is a situation in which supply of labour is equal to the demand of the labour (SL = DL). Under this, all the resources are fully utilized in an economy.

Note: Full Employment does not mean zero unemployment.

Under Employment: It refers to a situation wherein there is excess capacity in an economy or everyone who is capable and willing to work is not getting work at the existing work rate in an economy. It is a situation in which supply of labour is not equal to the demand of the labour (SL ≠ DL). Under this, all the resources are not fully utilized in an economy.

Natural Unemployment: Natural Unemployment refers to a situation that consists of some degree of unemployment which always exists in an economy or can’t be vanished from the economy. It is of two types namely;

  • Frictional unemployment: It is a type of unemployment which exists during the change of the job by a person. As per Gardner, ”Frictional unemployment is the unemployment associated with the changing of job in dynamic economy.”
  • Structural unemployment: It is another type of unemployment which exists in the economy due to change in the structure of economy or due to change in the way of work such as using of typewriter.  As per Gardner, “Structural unemployment is the unemployment that results from the long-term decline of certain industries.”

Voluntary Unemployment: It refers to a situation in which people get unemployed because they do not want to work at all or do not want to work at the existing wage rate even when work is available for them.

Involuntary Unemployment: It refers to a situation in which people can work and are willing to work at the existing wage rate but do not get work due to fall in the planned output in an economy.

Excess Demand (Inflationary Gap) – AD > AS

It refers to a situation wherein aggregate demand exceeds the aggregate supply in an economy corresponding to the complete level of employment in an economy and the producer has to suffer a loss of unfulfilled demand in the economy.

Inflationary Gap refers to the gap which shows the exact increase in the demand from the equilibrium demand or the gap which shows the difference of aggregate demand over aggregate supply corresponding to the full employment level in an economy. It is known as inflationary gap as it leads to inflation.

For instance:

Let’s suppose, a producer produces 100 units only by employing all the people but the demand in the market for that product is 150 units in number. However, the demand which exceeds the production is known as excess demand and the amount by which it exceeds i.e. 50 units (150 – 100) is known as inflationary gap in the excess economy. In the diagram below, inflationary gap is AB because at Full employment (Y*), Aggregate demand (BY*) is greater than Aggregate Supply (AY*).

Causes of Excess Demand

  • There is increase in the consumption level by the household due to increase in propensity to consume.
  • There is increase in the private investment level due to rise in credit facilities.
  • Both the expenditures of Government (public) expenditure increases.
  • The amount of export increases.
  • The amount of import decreases.
  • The money supply and disposable income increase.
  • Fall in the rate of taxes.

Effect of Excess Demand

General Price Level: The general price level increases because the aggregate demand increases but there is no aggregate supply. So, to manage the situation and to earn more, the producer increases the rate of the products.

Output: There is no increase in the level of output as all the workers are already employed.

Employment: The level of employment also does not change since all the workers are already employed and no worker is left unemployed.

Measures Taken

The Government along with RBI takes initiatives to make the economy in equilibrium from excess demand.

Measures taken by Government (Fiscal Policy)

Fiscal Policies refer to those policies which are formed by the government to make the excess demand in equilibrium condition. Some fiscal policies are as follows;

  • Government Expenditure: The government reduces the expenditure so that the less cash flows in the market and people have less cash in their hand to control the excess demand.
  • Taxes: The government increases tax rates so that more amount can be soaked from the people.
  • Public Debts: Government increases the public debt so that more cash can be soaked from the people to reduce the cash flow in the economy.

Measures taken by RBI (Monetary Policy)

Monetary policies refer to the tools which are used by the RBI (Reserve Bank of India) to control the flow in the market and to make the excess demand in equilibrium condition. Some monetary policies are as follows:

  • Repo Rate/Bank Rate: It is the amount which commercial bank takes from the central bank in the form of loan and the interest which is paid on the same is known as Bank rate or Repo Rate. To Control the excess demand, RBI increases the rate so that the commercial bank can put less cash for credit creation process.
  • Cash Reserve Ratio (CRR): It is the ratio that every commercial bank has to maintain from the total deposit with RBI. To control the excess demand RBI increases the ratio so that more cash can be kept in the reserve and less cash for credit creation process.
  • Statutory Reserve Ratio (SLR): It is the amount that every commercial bank has to put with himself in the form of cash and cash equivalent. To control the excess demand RBI increases the ratio so that more cash can be put in the reserve and less cash for credit creation process.
  • Marginal Requirement: It is the difference amount between the loan taken and loan granted. To control the excess demand, the central bank increases the rate so that less people will come to take loan.
  • Open Market Operation: The RBI sells the securities in the open market so that people can buy the securities and more cash can be availed from the market.
  • Moral Suasion: The RBI makes its rule stricter and pressurize commercial banks more to follow all the guidelines.
  • Rationing of Credit: RBI decreases the rate so that less cash can be given to the particular industry.

Deficient Demand (Deflationary Gap) – AD < AS

It refers to a situation wherein aggregate supply exceeds aggregate demand in an economy corresponding to the full level of employment in an economy or the situation in which aggregate demand falls short than the aggregate supply and the producer suffers loss of unsold stock in the economy, it can be called deficit demand. According to Keynes it is known as under employment equilibrium.

Deflationary Gap refers to the gap which shows the decrease in the aggregate demand from the equilibrium demand or the gap which shows the gap of deficiency in aggregate demand over aggregate supply corresponding to the full employment level in an economy. It is known as deflationary gap for it leads to deflation.

For example: Let’s suppose, a producer produces 100 units by employing all the workers but the demand in the market for that product is 50 units. However, the production which exceeds the demand is known as deficit demand and the amount by which it is deficit i.e. 50 units (100 – 50) is the deflationary gap in the deflationary economy.

Causes of Deficient Demand

  • Decrease in the consumption level by the household due to fall in propensity to consume.
  • Decrease in the private investment level due to fall in credit facilities.
  • Both the expenditures of Government (public) expenditure decreases.
  • The amount of export decreases.
  • The amount of import increases.
  • The money supply and disposable income decrease.
  • Increase in the rate of taxes.

Effect of Excess Demand

  • General Price Level: The general price level decreases because as the aggregate demand decreases but there is aggregate supply. However, the producer manages to take out his investment.
  • Output: Fall in the level of investment implies fall in the level of output.
  • Employment: The level of employment falls or causes involuntary unemployment as the investment is reduced by the producer.

Measures Taken

The Government along with RBI takes initiatives to make the economy in equilibrium from deficient demand.

Measures taken by Government (Fiscal Policy)

Fiscal Policies refer to those policies which are formed by the government to make the excess demand in equilibrium condition. Some fiscal policies are as follow;

  • Government Expenditure: The government increases the expenditure so that the more cash can flow in the market and people have more cash in their hand to control the deficit demand.
  • Taxes: The government decreases tax rates so that less amount can be soaked from the people.
  • Public Debts: Government decreases the public debt so that less cash can be obtained from the people to increase the cash flow in the economy.
  • Deficit Financing: It is a practice adopted for financing the excess expenditure with outside resources. Therefore the government increases such financing.

Measures Taken by RBI (Monetary Policy)

Monetary policies refers to the tools which are used by the RBI (Reserve Bank of India) to control the flow in the market and to make the excess demand in equilibrium condition. Some monetary policies are as follow;

  • Repo Rate/ Bank Rate: It is the amount which commercial bank takes from the central bank in the form of loan and the interest which is paid on the same is known as Bank rate or Repo Rate. To Control the deficit demand RBI decreases the rate so that the commercial bank can put more cash for credit creation process.
  • Cash Reserve Ratio (CRR): It is the ratio that every commercial bank has to maintain from the total deposit with RBI. To control the deficit demand RBI decreases the ratio so that less cash can be put in the reserve and more cash for credit creation process.
  • Statutory Reserve Ratio (SLR): It is the amount that every commercial bank has to put with himself in the form of cash and cash equivalent. To control the deficit demand RBI decreases the ratio so that less cash can be put in the reserve and more cash for credit creation process.
  • Marginal Requirement: It is the difference amount between the loan taken and loan granted. To control the deficit demand the central bank decreases the rate so that more people can come to take loan.
  • Open Market Operation: The RBI purchases the securities in the open market so that people can sell the securities and more cash can be liquidated in the market.
  • Moral Suasion: The RBI makes its rule liberal and pressurize commercial banks less to follow all the guidelines.
  • Rationing of Credit: RBI increases the rate so that more cash can be given to the particular industry.

Tables to Learn

Fiscal Policy

Particulars AD > AS AD < AS
Government Expenditure Reduce Increase
Taxes Increase Decrease
Public Debt Increase Decrease
Deficit Financing Yes

Monetary Policy

Particulars AD > AS AD < AS
Repo Rate/Bank Rate Increase Decrease
CRR Increase Decrease
SLR Increase Decrease
Margin Requirement Increase Decrease
Open Market Operation Sale Purchase
Moral Suasion Strict Liberal
Rationing of Credit Decrease Increase

You May Also Read Macroeconomics, Basic Concepts of Macroeconomics, National Income, Calculation of National Income, Barter System, Commercial Banks, Aggregate Demand, Excess Demand, Government Budget, Foreign Exchange, Balance of Payment for better understanding of what economics is and scoring higher in upcoming examination.

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