Question

Explain the concept of deficient demand with the help of aggregate demand and aggregate supply curves. Discuss one physical and one monetary measure to correct it.

Answer 1

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.

The situation of deficient demand arises when planned aggregate expenditure falls short of aggregate supply at the full employment level. It gives rise to the deflationary gap. A deflationary gap is a gap by which actual aggregate demand required to establish full employment equilibrium.

The concepts of deficient demand and deflationary gap are shown in the following figure.

1. In the given diagram, income, output and employment are measured on the X-axis and aggregate demand is measured on the 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 (ΔI), aggregate demand falls from AD to AD₁. It denotes the situation of deficient demand and the gap between them, i.e., EG is termed as a deflationary gap.
4. Point F indicates the underemployment equilibrium.

Physical measure: Increase in public expenditure (the government spends more on public works).

Monetary measure: Increase in money supply (credit expansion/reduction in bank rate).