Question

Give consequences of excess demand.

Answer 1

1. Inflation: When aggregate demand surpasses the supply at full employment, price levels rise, causing inflation. This is due to excessive demand pushing prices up without an increase in output.
2. No Increase in Output: At full employment, output cannot increase further because resources are fully employed, so excess demand doesn’t increase production.
3. Shortage of Goods: Excess demand results in shortages, as demand exceeds supply, leading to higher prices.
4. Inflationary Gap: The economy experiences an inflationary gap, defined as the amount by which actual demand exceeds full employment supply.
5. Pressure on Prices: Additional demand pressure leads to rising prices across goods and services proportionate to excess demand.
6. Discouragement to Investment: Inflation caused by excess demand can reduce profits, discouraging investment.