Concept Excess Demand
Excess demand refers to the situation where aggregate demand is more than the aggregate supply corresponding to full employment level in the economy.
Inflationary gap refers to the gap by which actual aggregate demand exceeds the aggregate demand required to be establish at full employment equilibrium.
Concept Measures to Correct Excess Demand
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1. |
Change in government spending or expenditure |
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2. |
Increase in taxes |
1. Change in Government Spending or Expenditure
Expenditure on Defence
Expenditure on Law and Order
Dictation
Incease in government spending during the situation of excess demand government will reduce its expenditure to the maximum possible extent. As decrease in government spending will reduces the level of aggregates demand in the economy and helps to correct the inflationary pressure in the economy.
Increase in Taxes
During excess demand government increases the taxes or may even imposes the new taxes which leads to decrease in the level of aggregate expenditure in the economy and helps to control the situation of excess demand.
Monetary Policy
1. Quantitative Instruments
2. Qualitataive Instrument
Increase in Bank Rate
Bank rate is the rate at which the central bank lends money to commercial bank to meet their long term terms needs. During excess demand central bank increase thebbank rate, which raises the cost of borrowing from the central. Bank .it forces the commercial bnak to increases their lending ratews which discourages borrower from taking loans .it reduces the availability of credit in the economy and helps to correct excess demand.
Increase in Repo Rate
Bank rate is the rate at which the central bank lends money to commercial bank to meet their short term terms needs. During excess demand central bank increase the bank rate, which raises the cost of borrowing from the central. Bank .it forces the commercial bnak to increases their lending ratews which discourages borrower from taking loans .it reduces the availability of credit in the economy and helps to correct excess demand.
Open Market Operation
Open market operation refers to sale and purchase of securities in the open market by the central bank. it directly influences the level of money supply in the economy. During excess demand central bank offers securities for sale .sale of securities reduces the reserve of commercial bank .it adversely affect the banks ability to create credit and decrease the level of aggregate demand in the economy.
Increase in LRR
Commercial bank are obliged to maintain legal resreves. There are two types of reserves.
During excess demand, the central bank increases the CRR/SLR. It reduces the amount of effective cash resources of commercial bank and limit their credit creating power .it ultimately helps in reducing credit availability in the economy.
Qualitative Instrument
Marginal Requirement
Increase in marginal requirement so, the difference between the value of security and value of loan is called marginal requirement. In a situation of excess demand leading to inflation, central bank raises marginal requirements. This discourages borrowing because it makes people get less credit against their securities.
Moral Suasion
Moral suasion
Selective Credit Control
Selective Credit
It refers to a method in which the central bank gives direction to other bank to give or not to give for certain purposesto particular sector .during excess demand the central bank introduces rationing of credit in order to prevent excessive flow of credit ,particularly for speculative activites. It helps to correct the excess demand.
Concept Deficit Demand
Deficit demand refers to the situation when Aggregate Demand (AD) is less than the Aggregate Supply (AS) corresponding to full employment level of output in the economy.
AD
AD
Deficit Demand
Deflationary gap refers to the gap by which actual aggregate demand fall short of the aggregate demand required to be establish at full employment equilibrium.
Concept Measures to Correct Deficit Demand
a. Fiscal policy
b. Monetary policy
Increase in Government Spending
Government spending is a part of the Fiscal Policy.
As we know government incurs expenditure on infrastructural and administrative activities, During deficient demand the government should increase expenditure like construction of roads flyovers building etc. with a view to provide additional income to the people. This will increase the aggregate demand and will help to correct the situation of deficient demand.
Decrease in Taxes
Decrease in taxes
During deficit demand government reduces the taxes or may even abolish the taxes which leads to raises in the level of aggregate demand in the economy and helps to control the situation of deficit demand.
Monetary Policy
1. Quantitative Instruments
2. Qualitataive Instrument
Quantitative Instruments
Decrease in bank rate
Bank rate is the rate at which the central bank lends money to commercial bank to meet their long term terms needs. During deficit demand central bank reduces the bank rate, in order to expand credit .it leads to fall in the market rate of interest which induces the people to borrow more funds ..
Increase in repo rate
Repo rate is the rate at which the central bank lends money to commercial bank to meet their short term terms needs. During deficient demand central bank decreases the repo rate, which reduces the cost of borrowing from the central. Bank. It forces the commercial bnak to decreases their lending ratews which encourages borrower for taking loans. It increases the availability of credit in the economy and helps to correct deficient demand.
Open market operation
Open market operation refers to sale and purchase of securities in the open market by the central bank. it directly influences the level of money supply in the economy .during deficit demand central bank purchase securities .purchase of securities increases the reserve of commercial bank .it encourages the banks ability to create credit and increase the level of aggregate demand in the economy.
Commercial bank are obliged to maintain legal resreves .there are two types of reserves.
During deficit demand, the central bank decreases the CRR/SLR. It increases the amount of effective cash resources of commercial bank and enhance their credit creating power. It ultimately helps in raising the credit availability in the economy.
Qualitative Instrument
Decrease in margin requirement
The difference between the value of security and value of loan is called margin requiremen. In a situation of deficit demand, central bank reduces the margin which enhance the credit creating power of banks. With decrease in the margin, commercial bank can grant more loans than before, against the same amount of security. It encourages the borrowes to borrow more money from and raises the level of aggregate demand.
Moral Suasion (encourage lending rates)
The central bank advises, requests or persuades the commercial banks to encourage credit
Dictation
Moral suasion
Selective Credit Control
Selective credit (withdraw credit rationing)
It refrs to a method in which the central bank gives direction to other bank to give or not to give for certain purposesto particular sector. during deficit demand the central bankwithdarw rationing of credit and make efforts to encourage credits..
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