Chapter 9: Problem of Deficient demand and Excess demand
Voluntary unemployment
It refers to a situation when some people are not willing to work at all or are not willing to work at the
existing wage rate.
Involuntary unemployment
It occurs when some people are not getting work even when they are willing to work at the existing
wage rate. The economy fails to create enough jobs because planned output is lower than potential
output due to lack of aggregate demand.
Full employment and Natural unemployment
Full employment refers to a situation when all those who are able to work and are willing to work at the
existing wage rate are getting work. It is a situation when corresponding to a given wage rate demand
for labour is equal to supply of labour and the labour market is clear. Full employment does not mean
zero unemployment.
Natural rate of unemployment refers to the rate of unemployment which always exists in the economy
even when the labour market is in a state of equilibrium or there is full employment. It occurs due to
a) frictional unemployment (changes related to shifting from one job to the other)
b) Structural unemployment ( changes related to new production technology)
Full employment equilibrium
It refers to a situation when aggregate demand is equal to aggregate supply at full employment level i.e.,
all the resources of the economy are fully utilized.
AS=Y
AD
AD (C+I)
E
X
0 M
Income/output/employment
In the figure E is full employment equilibrium because aggregate demand EM is equal to full
employment level of output OM.
Under employment equilibrium
It refers to a situation when the AD = AS and the resources are not fully employed. It occurs prior to the
full employment level.
Y
AS=Y
Aggregate
AD Full employment level
Demand E
AD underemployment level
F
0 X
Q1 Q
Income/output
In the figure, AD = AS at point F which is lower than full employment level. As OQ 1 is less than OQ, point
F signifies the underemployment equilibrium.
Deficient demand (Deflationary gap)
Deficient demand refers to the situation when AD is less than AS corresponding to full employment in
the economy.
AD < AS; Corresponding to full employment
The situation of deficient demand arises when planned AD falls short of AS at the full employment level.
It gives rise of deflationary gap. Deflationary gap is the gap by which actual aggregate demand falls short
of aggregate demand required to establish full employment equilibrium.
The concept of deficient demand and deflationary gap are shown in the following figure.
Y
AS=Y
Deflationary gap or deficient demand
Aggregate
demand ADF (C+I)( Full employment AD)
E
ADP(C + I ─ ∆I) (Planned AD)
F
G
0 X
M1 M
Income/output/ employment
In the figure, income/output/employment is measured on the X-axis and AD on the Y-axis. Aggregate
demand (ADF) and aggregate supply (AS) curve intersects at point E which indicates the full employment
equilibrium. Due to decrease in investment expenditure (∆I) aggregate demand falls from ADF to ADP. It
denotes the situation of deficient demand and the gap between them i.e. EG is termed as deflationary
gap. Point F indicates the underemployment equilibrium.
Causes of Deficient demand:
AD = C + I + G + X ─ M
1) Reduction in private consumption expenditure (C):
Reduction in private consumption expenditure causes a serious deficiency in aggregate demand.
Private consumption expenditure may reduce due to reduction in propensity to consume or
increase in propensity to save.
2) Reduction in private investment expenditure (I):
Private investment expenditure may reduce in situations of poor business expectations and
thereby reduce the level of aggregate demand in the economy.
3) Reduction in Government expenditure (G):
The government may cut its consumption expenditure or investment expenditure because of
the budgetary constraints of the government. A cut in government expenditure leads to a cut in
AD.
4) Decline in Exports (X):
Exports are positive component of AD. A fall in exports implies a fall in expenditure on the
domestically produced goods and services. This leads to a fall in AD.
5) Rise in imports (M):
Imports are a negative component of AD. Accordingly, a rise in imports leads to a fall in AD.
6) Increase in tax rates:
Increase in tax rates decreases disposable income of the people. It reduces their capacity to
spend resulting lower level of AD.
Consequences of Deficient demand:
1) Underemployment equilibrium:
Owing to the deficiency of AD, producers are not able to fully utilise their resources or
productive capacity. Planned output remains less than potential output. Accordingly,
underemployment equilibrium is struck in the economy.
2) Deflationary gap:
Deficiency of demand creates deflationary gap in the economy. It is a situation when lack of
demand leads to deflationary pressure in the economy. Inducement to invest is hurt. Low
investment leads to low output. Implying low income, low demand and falling prices. The
economy starts slipping into low level equilibrium trap.
3) Undesired stocks:
Ina situation of low AD, producers are not able to sell all that they plan to sell. Accordingly
undesired stocks tend to pile up. Clearance of undesired stocks often lead to fall in prices
and fall in planned output for the year ahead.
4) Loss of profits:
Deficiency of AD causes loss of profits. This happens because producers are not able to clear
their stocks and undesired stocks lead to ‘price crash’.
