PPT CHAPTER 9 Economics_4ea154fa-3451-4989-a366-f35d3cda5b82.pdf

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1. Class 12 Macroeconomics

2. Excess Demand
Excess demand refers to the situation when aggregate demand
(AD) is more than the aggregate supply (AS) corresponding to
the full employment level of output in the economy.
1)Income/output/employment are measured on X-axis and
aggregate demand is measured on Y-axis.
2)The aggregate demand (AD) and aggregate supply (AS) curves
intersect at point E, which indicates the full employment
equilibrium.
3)Due to an increase in investment expenditure (ΔI), aggregate
demand rises from AD to AD
1.
4)It denotes the situation of excess demand and the gap between
them, i.e., EF is termed an inflationary gap.
5)The inflationary gap refers to the gap by which actual aggregate
demand exceeds the aggregate demand required to establish full
employment equilibrium.
X
Full Employment
Equilibrium
45°
Income / Output / Employment
AD
1 (C + I + ∆ I)
Y
O M
E
F
Aggregate Demand (AD)

Excess Demand &
Inflationary Gap
Inflationary Gap (EF)
Y (or AS)
AD (C + I)

3. Reasons For Excess Demand
Excess demand may arise because of an increase in
consumption expenditure due to a rise in the propensity to
consume or a fall in the propensity to save.
Rise in the
propensity to
consume
It may also occur due to an increase in disposable income
and consumer demand because of a decrease in taxes.
Reduction in
taxes
A rise in government demand for goods and
services due to an increase in public expenditure
will also result in excess demand.
Increase in
government
expenditure

4. A decrease in imports due to higher international
prices may also lead to excess demand.
Fall in imports
Excess demand may also arise when demand for exports
increases due to comparatively lower prices of domestic
goods or due to a decrease in the exchange rate for
domestic currency
Rise in
exports
Excess demand may be caused due to increase in the
money supply caused by deficit financing.
Deficit
Financing
Excess demand can also arise when there is an
increase in investment due to a decrease in the
rate of interest or an increase in expected return
Increase in
Investment

5. Excess demand has the following effect on output,
employment, and general price level
b)Effect on Employment
oThere 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.
a)Effect on Output
oExcess demand does not affect the level of output because the economy is
already at full employment level and there is no idle capacity in the
economy.
c)Effect on General Price Level
oExcess demand leads to a rise in the general price
level (known as inflation) as aggregate demand
is more than aggregate supply.

6. Deficient Demand
Deficient demand refers to the situation when aggregate
demand (AD) is less than the aggregate supply (AS)
corresponding to the full employment level of output in the
economy.
1)Income/output/employment are measured on X-axis and aggregate
demand (AD) is measured on Y-axis.
2)Aggregate demand (AD) and aggregate supply (AS) curves intersect at
point E, which indicates the full employment equilibrium.
3)Due to a decrease in investment expenditure, (Δ I), aggregate demand
falls from AD to AD1.
4)It denotes the situation of deficient demand and the gap between
them, i.e., EG is termed a deflationary gap.
5)A deflationary gap is a gap by which actual aggregate demand falls
short of the aggregate demand required to establish full employment
equilibrium.
6)Point F indicates the under-employment equilibrium.
Income / Output / Employment
45°
G
X
O M
F
E
Deflationary
Gap (EG)
Aggregate Demand (AD)

Deficient Demand &
Deflationary Gap
Full Employment
Equilibrium
Y (or AS)
AD
1 (C + I - ∆ I)
AD (C + I)
Y

7. AD may also fall due to the imposition of higher taxes. It leads to a decrease in
disposable income and, as a result, the economy suffers from deficient demand.
Increases in taxes
When the government reduces its demand for goods and services due to a fall in
public expenditure, it leads to deficient demand.
Decrease in government
expenditure
When international prices are comparatively less than domestic prices, then it
may lead to a rise in imports, implying a cut in the aggregate demand
The rise in imports
Exports may fall due to comparatively higher prices of domestic goods or due to
an increase in the exchange rate for domestic currency
This will lead to deficient demand.
Fall in exports
A decrease in consumption expenditure, due to a fall in the
propensity to consume, leads to deficient demand in the economy.
Decrease in propensity
to consume
An increase in the rate of interest or a fall in the expected returns
leads to a decrease in investment expenditure.
It reduces AD and gives rise to deficient demand
Fall in investment
expenditure
Reasons For Deficient Demand

8. Impacts Of Deficient Demand
Effect on Output
Effect on
Unemployment
Effect on General
Price Level
Due to a lack of sufficient aggregate demand, there will be
an increase in the inventory stock.
It will force the firms to plan for lesser
production for the subsequent period.
As a result, the planned output will fall.
Deficient demand causes involuntary unemployment in the
economy due to a fall in the planned output.
Deficient demand causes general prices to fall due to a lack
of demand for goods and services in the economy.

9. Basis Excess Demand Deficient Demand
Meaning
It refers to the situation when AD is more
than AS corresponding to a full
employment level in the economy
It refers to the situation when AD is
less than AS corresponding to a full
employment level in the economy
Inflationary or
Deflationary Gap
It leads to an inflationary gap It leads to a deflationary gap.
Equilibrium level
It indicates over full employment
equilibrium.
It indicates employment equilibrium.
Reason
It occurs due to excess anticipated
expenditure, i.e. due to a rise in
consumption expenditure, investment
expenditure, etc.
It occurs due to a shortage of
anticipated expenditure, i.e. due to a
fall in consumption expenditure,
investment expenditure, etc.
Impact on output
and employment
It does not affect the output and
employment as the economy is already
operating at a full employment level.
It leads to a fall in output and
employment due to a shortage of
aggregate demand.
Impact on price
It leads to inflation, i.e. it results in a rise
in the general price level.
It leads to deflation, i.e. it results in a
fall in the general price level.
Differences Between Excess Demand And Deficient Demand

10. 1)Change in government Expenditure :
This measure is a part of fiscal policy and is termed the 'Expenditure
Policy' of the government.
The government spends huge amounts on public works like the
construction of roads, flyovers, buildings, railway lines, etc.
Change in such expenditure directly affects the level of AD in the
economy and helps to control the situation of excess and deficient
demand.
2)Change in taxes :
‘Taxes’ is the main source of revenue for the government.
This measure is a part of fiscal policy and is termed the 'Revenue Policy'
of the government.
Changes in taxes by the government directly influence the level of
aggregate demand in the economy and help to control excess and
deficient demand.
Measures to Control Excess and Deficient Demand

11. i.Quantitative instruments :
These instruments aim to
influence the total volume of
credit in circulation.
Major instruments are-
a)Bank Rate and Repo Rate
b)Open Market Operation,
and
c)Legal Reserve
Requirements
3)Change in money supply or availability of credit :
The Reserve Bank of India is empowered to regulate the money supply in
the economy through its ‘Monetary Policy’.
It is the policy of the central bank to control the money supply and credit
creation in the economy.
Monetary policy helps to control the situations of excess and deficient
demand through its following instruments
ii.Qualitative instruments :
These instruments aim to
regulate the direction of
credit.
Major qualitative instruments
are-
a)Margin requirements
b)Moral suasion
c)Selective credit controls

12. Measures to Correct Excess Demand
Fiscal Policy
(Policy of Central Government)
Monetary Policy
(Policy of Central Bank)
Increase in
Taxes
Quantitative
Instruments
Qualitative
Instruments
1)Increase in Bank
Rate
2)Increase in Repo
Rate
3)Sale of Securities
4)Increase in LRR
1)Increase in Margin
Requirements
2)Advice to Discourage
Lending / Moral
Suasion
3)Credit Rationing
under SCC
4)Increase in LRR
Decrease in
government
spending

13. It is a part of fiscal policy.
The government spends huge amounts on infrastructural
and administrative activities.
To control the situation of excess demand, the government should reduce its
expenditure to the maximum possible extent.
A decrease in government spending will reduce the level of aggregate
demand in the economy and helps to correct inflationary pressures in the
economy
Decrease in
government
spending :
During excess demand, the government increases the rates of taxes and even
imposes some new taxes.
It leads to a decrease in the level of aggregate expenditure in the economy
and helps to control the situation of excess demand
Increase in
taxes :
The central bank (RBI) aims to reduce availability of credit in the economy
through its ‘Monetary Policy’.
For this purpose , two major instruments are-
(i) Quantitative Instruments (ii) Qualitative instruments
Decrease in money
supply or availability
of credit :

14. 1)Increase in Bank Rate :
The bank rate is the rate at which the central bank lends money to commercial banks to meet their long-term needs.
During excess demand, the central bank increases the bank rate, which raises the cost of borrowing from the central bank.
It forces commercial banks to increase their lending rates, which discourages borrowers from taking loans.
It reduces the availability of credit in the economy and helps to correct excess demand.
2)Increase in Repo Rate :
The repo rate is the rate at which the central bank lends money to commercial banks to meet their short-term needs.
During excess demand, the central bank increases the repo rate, which increases the cost of borrowing from the central bank.
As a result, commercial banks are forced to increase their lending rates.
It discourages the borrowers from taking loans and reduces the availability of credit in the economy, which helps to correct the
excess demand.
3)Open Market Operations (sale of securities) :
It refers to the sale and purchase of securities in the open market by the central bank.
During excess demand, the central bank offers securities for sale which reduces the reserves of commercial banks.
It adversely affects the bank’s ability to create credit and decreases the level of aggregate demand in the economy.
4)Increase in legal reserve requirements (LRR) :
Commercial banks are obliged to maintain legal reserves.
An increase in such reserves is a direct method to reduce the availability of credit.
It includes :
(i)Cash Reserve Ratio (CRR) : It is the minimum percentage of net demand and time liabilities,
to be kept by commercial banks with the central bank.
(ii)Statutory Liquidity Ratio (SLR) : It refers to the minimum percentage of net demand and
time liabilities, which commercial banks are required to maintain themselves.
To correct excess demand, the Central bank increases CRR or/ and SLR. It reduces the number of effective cash resources of
commercial banks and limits their credit-creating power which ultimately helps in reducing credit availability in the economy.
i.Quantitative instruments :

15. 1)Increase in margin requirements :
It refers to the difference between the market value of the security offered and
the value of the amount lent.
When the economy is suffering from excess demand, the central bank increases
the margin, which restricts the credit creation power of banks.
It decreases the level of aggregate demand.
2)Selective Credit Controls (introduce credit rationing) :
It refers to a method in which the central bank gives directions to other banks to give credit or not to
particular sectors for certain purposes.
During excess demand, the central bank introduces the rationing of credit to prevent excessive flow of
credit, particularly for speculative activities.
It helps to wipe off the excess demand.
3)Moral suasion (advise to discourage lending) :
This is the combination of persuasion and pressure that the central bank applies on other banks to get
them to act, in a manner with its policy.
During excess demand, the central bank advises commercial banks not to advance credit for
speculative or non-essential activities.
It helps to reduce the availability of credit and aggregate demand.
ii.Qualitative instruments :

16. Measures to Correct Deficient Demand
Fiscal Policy
(Policy of Central Government)
Monetary Policy
(Policy of Central Bank)
Quantitative
Instruments
Qualitative
Instruments
1)Decrease in Bank
Rate
2)Decrease in LRR
3)Purchase of
Securities
1)Decrease in Margin
Requirements
2)Advice to
Encourage Lending
3)Withdraw Credit
Rationing under
SCC
Increase in
Government
Spending
Decrease in
Taxes

17. The central bank (RBI) aims to ensure the easy availability of credit and reduce the cost of
borrowing money through its ‘Monetary Policy’ in deflationary situations.
For this purpose, two major instruments are :
(i)Quantitative Instruments
(ii)Qualitative instruments
During deficient demand, the government reduces the rates of taxes and even abolishes some of the taxes which
raises the purchasing power of people.
It raises the level of aggregate demand in the economy and helps to control the situation of deficient demand.
It is a part of fiscal policy.
The government spends huge amounts on infrastructural and administrative activities.
During deficient demand, the government should increase expenditure on public works like
the construction of roads, flyovers, etc.
This will increase the level of aggregate demand and help to correct the situation of deficient demand.
a)Increase in government spending :
b)Decrease in taxes :
c)Increase in money supply or availability of credit :

18. 1)Decrease in Bank Rate-
The bank rate is the rate at which the central bank lends money to commercial banks to meet their long-term needs.
During deficient demand, the central bank reduces the bank rate to expand credit.
It leads to a fall in the market rate of interest which induces people to borrow more funds.
It leads to an increase in aggregate demand.
2)Decrease in Repo Rate-
The repo rate is the rate at which the central bank lends money to commercial banks to meet their short-term needs.
During deficient demand, the central bank decreases the repo rate to expand credit.
It leads to a fall in interest rates which helps to increase the aggregate demand and induces people to borrow more funds. It
leads to an increase in AD.
3)Open Market Operations ( purchase of securities)-
It refers to the sale and purchase of securities in the open market by the central bank.
During deficient demand, the central bank starts purchasing securities from the open market.
It enhances the purchasing power capacity which increases the level of aggregate demand in the economy.
4)Decrease in legal reserve requirements (LRR)-
Commercial banks are obliged to maintain legal reserves.
A decrease in such reserves helps to raise the availability of credit.
It includes:-
(i)Cash Reserve Ratio (CRR) : It is the minimum percentage of net demand and time liabilities, to be kept by commercial
banks with the central bank.
(ii)Statutory Liquidity Ratio (SLR) : It refers to the minimum percentage of net demand and time liabilities, which
commercial banks are required to maintain themselves.
Central bank decreases CRR or/ and SLR to correct deficient demand. It increases the number of effective cash resources of
commercial banks and enhances their credit-creating power.
i.Quantitative Instruments :

19. 1)Decrease in margin requirements :
It refers to the difference between the market value of the security
offered and the value of the amount lent.
During deficient demand, the central bank decreases the margin,
which enhances the credit creation power of the bank.
It increases the level of aggregate demand when borrowers are
encouraged to borrow more money.
2)Selective Credit Controls (introduce credit rationing) :
It refers to a method in which the central bank gives directions to other banks to give
credit or not to particular sectors for certain purposes.
During deficient demand, the central bank withdraws the rationing of credit and makes
efforts to encourage credit.
3)Moral suasion (advise to discourage lending) :
This is the combination of persuasion and pressure that the central bank applies on other
banks to get them to act, in a manner with its policy.
During deficient demand, the central bank advises commercial banks to encourage credit.
It helps to raise the availability of credit and aggregate demand.
ii.Qualitative Instruments :

20. Important
Formulas
1)AD = C + I
2)AS = Y = C + S
3)APC =
??????
??????
, 1 – APS
4)APS =
??????
??????
, 1 – APS
5)MPC =
Δ??????
Δ??????
, 1 – MPS
6)MPS =
Δ??????
Δ??????
, 1 – MPC
7)C = ?????? + bY
8)S = -C + (1 – b) y
9)K =
Δ??????
Δ??????
=
1
1 −??????????????????
=
1
??????????????????