Access Demand and Deficient Demand

  

Difference between Access demand (AD>AS) and Deficient demand (AD<AS):

S.No.	Access demand (AD>AS)	Deficient demand (AD<AS)
1	It refers to the situation where AD is more than AS correspondingly to full employment level of output in an economy.	It refers to the situation where AD is less than AS correspondingly to full employment level of output in an economy.
2	It causes inflationary gap.	It causes deflationary gap.
3	Inflationary gap refers to a state in which actual AD exceeds the required AD to establish full employment equilibrium.	Deflationary gap refers to a state in which actual AD falls short to the required AD to establish full employment equilibrium.
4	It happens because of increase in investment expenditure.	It happens because of decrease in investment expenditure.

Access demand curve:

In the above diagram, output is measured on x-axis and aggregate demand on y-axis. Point E denotes full employment equilibrium as AD = AS. Due to increase in investment expenditure (ΔI), showing an inflationary gap (EF).

Deficient demand curve:

In the above diagram, output is measured on x-axis and aggregate demand on y-axis. Point E denotes full employment equilibrium as AD = AS. Due to decrease in investment expenditure (ΔI), AD falls from AD to AD₁ showing a deflationary gap (EF).

What are the reasons for excess demand?

The following reasons will explain for the situation of excess demand:

• Rise in consumer’s propensity: Excess demand may arise because of increase in consumption expenditure due to rise in the propensity to consume.
• Reduction in taxes: It may also occur due to increase in disposable income and consumption demand because of decrease in taxes.
• Increase in government expenditure: Rise in government demand for goods and services due to increase in public expenditure will also result in excess demand.
• 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.

Impact of excess demand:

• Effect on output: Excess demand doesn’t affect the level of output because economy is already at full employment level and there is no idle capacity in the economy.
• Effect of 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.
• Effect on general price level: Excess demand leads to rise in the general price level called inflation as AD is more than AS.

What are the reasons for deficient demand?

The following reasons will explain for the situation of deficient demand:

• Decrease in consumer’s propensity: A decrease in consumption expenditure due to fall in the propensity to consume, leads to deficient demand in the economy.
• Increase in taxes: Aggregate demand may fall due to imposition of higher taxes. It leads to decrease in disposable income and as a result, the economy suffers from deficient demand.
• Decrease in government expenditure: When government reduces its demand for goods and services due to fall in public expenditure, it leads to deficient demand.
• Fall in investment expenditure: Increase in the rate of interest or fall in the expected returns leads to decrease in the investment expenditure. It reduces AD and gives rise to deficient demand.

Impact of deficient demand:

• Effect on output: Due to lack of sufficient AD, these will be an increase in the stock. It will force the firms to plan for lesser production for the period. As a result, planned output will fall.
• Effect on employment: Deficient demand causes involuntary unemployment in the economy due to fall in the output.
• Effect on general price level: Deficient demand causes the general price to fall due to lack of demand for goods and services in the economy.

Measures to correct Excess demand and deficient demand:   

S.No.	Fiscal policy measures	Monetary policy measures
1	These measures refer to the use of the central government’s legal powers to tax and spend in order to achieve economic objectives.	These measures refer to the exercising of powers of by the central bank of the country influence money supply to achieve economic objectives.
2	Imposing taxes affect the purchasing power of the people and changing the government expenditure affects government demand for goods. Thus, effects in aggregate demand in the country.	Central bank has the power to influence money supply in a country. Thus, change in money supply can influence aggregate demand.

Fiscal measures:

·         Government spending:

Case1: During excess demand, the government spends amount on infrastructural and administrative activities. To control the situation of excess demand, government should reduce its expenses to the maximum possible limit. More emphasis should be placed to reduce expenditure on defense and unproductive works as they rarely help in growth of a country. Decrease in government spending will reduce the level of aggregate demand in the economy and help to correct inflationary pressure in the economy.

Case2: During deficient demand, the government incurs expenditure on infrastructure and administrative activities. The government should increase expenditure on public works like construction of roads, flyovers, buildings, etc. with a view to provide additional income to the people. This will increase the aggregate demand and also help to correct deflationary gap or deficient demand.  

·         Taxes:

Case1: During excess demand, tax is a compulsory payment paid by the people of the country to the government. Increase in tax rates will affect the purchasing power of the people. Due to this, the disposable income tends to fall which in turn decreases the demand for goods and services. Thus, excess demand is controlled and inflationary gap is met.

Case2:  During deficient demand, tax is a compulsory payment paid by the people of the country to the government. Decrease in tax rates will affect the purchasing power of the people. Due to this, the disposable income tends to rise which in turn to increase the demand for goods and services. Thus, deficient demand is controlled and deflationary gap is met.

Monetary measures:

·       Quantitative measures:

1.      Repo rate: It is the interest rate at which commercial banks borrow from central bank to meet their short-term needs (up till only 7days).
2.      Reverse repo rate: It is the interest rate at which the commercial banks can deposit their funds with the central bank. Or it is a rate at which central bank borrows money from commercial banks.
3.     Bank rate: It is the rate of interest at which commercial banks borrow money from central to meet their long-term needs.
4.       Legal reserve ratio: It is that fraction of deposits with the banks which is legally compulsory for the banks to keep in the form of cash and liquid assets are reserves.
5.      Open market situation: It refers to buying and selling of securities mainly government by the central bank to the general public in open market.

·       Qualitative measures: 

1.      Moral suasion: It is the combination of persuasion and pressure in the form of discussions, letters, etc by the central bank to the commercial bank to restrict or expand credit.
2.       Margin requirement of loan: It is the difference between the amount of loans and market value of the security offered by the borrower against the loan

   For example, if margin is 40% which is fixed by the central bank, then the commercial banks are
   allowed to give a loan only up to 60% of the value of the    mortgage goods.

Q. Can an economy be at equilibrium at less than full employment?

Or

   Explain under-employment equilibrium?

Or

    Can equilibrium only take place at full employment level of income?

Yes, an economy can be in equilibrium at less than full employment income level of the economy. This happens because of deficiency in aggregate demand (AD) in the economy.

Curve:

                E= full employment equation
                E1= under-employment equation
In the above diagram, output is measured in x-axis and aggregate demand (AD) on y-axis. Point E indicates the full employment equilibrium as AD is equal to AS. Due to decrease in investment expenditure (ΔI), aggregate demand falls from AD to AD₁. This is a situation of deficient demand and the gap between them is called deflationary gap (EE₁). The point E₁ indicates underemployment equilibrium.

Differentiate between Inflationary gap and Deflationary gap: 

S.No.	Inflationary gap	Deflationary gap
1	It refers to the gap by which actual AD exceeds at full employment level.	It refers to the gap by which actual AD falls short of AS at full employment level.
2	It doesn’t affect the output and employment level as economy is already operating at full employment level.	It leads to fall in output and employment due to shortage of aggregate demand.
3	It leads to inflation i.e. it results in rise in general price level.	It leads to deflation i.e. it results in full general price level.

 Curve of Inflationary gap:
  

  Curve of Deflationary gap:

Difference between Full employment and underemployment equilibrium:

S.No.	Full employment equilibrium	Underemployment equilibrium
1	It refers to a situation when AD=AS and all those who are willing and able to work at a given wage rate get work without any difficulty.	It refers to a situation when AD=AS and all these who are willing and able to work at a given wage rate don’t get work.
2	At this point, the real output is maximum.	At this point, real output is not maximum.
3	Any excess in AD over AS correspondingly to full employment level leads to inflationary gap.	Any excess of AD over AS beyond underemployment leads to a deflationary gap.