- Deficient demand occurs when aggregate demand is less than aggregate supply at full employment, causing a deflationary gap.
- It leads to fall in output, income, employment, and prices, resulting in underemployment equilibrium.
- Causes include fall in consumption, investment, government spending, and money supply.
- It is corrected by increasing aggregate demand through lower taxes, higher public spending, easy credit, and export promotion.
Definitions [1]
Definition: Inflationary Gap
“Inflationary gap is an excess of total disposable income over the value of the available supply of goods at a specified price level sufficient to cause an inflation of prices.” — Webster Dictionary
“The inflationary gap is defined as the excess of aggregate demand over the available supply of output measured at the full employment level of money income at existing level of prices.” — Dernburg and McDougall
“Inflationary gap is then the difference between what the population will try to consume out of their income and the amount available for consumption at pre-inflation prices.” — Dr. Klein
Formulae [1]
Formula: Deflationary Gap
Deflationary Gap = ADF − ADU = GK
| Symbol | Meaning |
|---|---|
| ADF | AD needed for Full Employment (the ideal level) |
| ADU | AD at Underemployment (the actual, lower level) |
Since ADU<ADF, the gap is positive — meaning demand is missing.
Key Points
Key Points: Types of Employment Equilibrium
- Full Employment Equilibrium: Occurs when aggregate demand (AD) equals aggregate supply (AS) at full use of resources; all willing workers get jobs at the prevailing wage.
- Under-Employment Equilibrium: AD = AS but at less than full employment due to deficient demand; resources and labour are underutilised (Keynesian view).
- Over-Employment Equilibrium: AD exceeds full-employment AS; output cannot rise further, so prices increase, leading to inflation.
Key Points: Deficient Demand
Key Points: Excess Demand
- Excess Demand occurs when aggregate demand exceeds aggregate supply at full employment, leading to inflation (inflationary gap).
- It is caused by rise in consumption, investment, government spending, exports, or money supply.
- It is corrected by reducing aggregate demand using fiscal policy (higher taxes, lower public spending), monetary policy (higher bank rate, CRR, open market sales), increasing imports, or raising output.
- Deficient Demand occurs when aggregate demand is less than aggregate supply at full employment, leading to unemployment (deflationary gap).
- It is corrected by increasing aggregate demand through lower taxes, higher government spending, easy credit policy, and increase in investment and exports.
Key Points: Deflationary Gap
- Deflationary gap arises due to deficient aggregate demand, leading to low output, income, and employment.
- It is the difference between aggregate demand required for full employment (ADF) and actual aggregate demand at underemployment (ADU).
- Deflationary Gap = ADF − ADU.
- A larger deflationary gap means greater deflationary pressure in the economy.
Key Points: Inflationary Gap
- Introduced by J.M. Keynes in "How to Pay for the War"
- Formula: Disposable Income − Net Output for Consumption
- Arises only at full employment when AD > AS
- Only prices rise — employment and output stay the same
- Fixed by contractionary fiscal and monetary policy
Key Points: Difference between Deficient Demand and Excess Demand
| # | Basis | Deficient Demand | Excess Demand |
|---|---|---|---|
| 1 | Meaning | AD is less than AS at full employment | AD is more than AS at full employment |
| 2 | AD vs AS | AD < AS | AD > AS |
| 3 | Gap Created | Deflationary Gap | Inflationary Gap |
| 4 | Output & Employment | Both decrease | No change (already at full employment) |
| 5 | Price Level | Falls (deflation) | Rises (inflation) |
Key Points: Cyclical Fluctuations
- Cyclical fluctuations arise due to changes in aggregate demand, causing ups and downs in economic activity.
- Boom occurs due to excess demand and inflationary pressure; recession and depression occur due to a fall in demand and deflation.
- Recovery begins when aggregate demand rises again, leading to better use of resources.
- The cycle moves as Boom → Recession → Depression → Recovery → Boom repeatedly.
