Question

What is excess demand? Illustrate it graphically.

Answer 1

‘Excess demand’ refers to the situation where aggregate expenditure is more than the aggregate output at the full employment level. In the diagram, OY_f (or BY_f) represents the level of output when the economy is fully employed.

According to the AE curve, the desired level of aggregate expenditure at full employment income is AY_f. Therefore, the excess demand is the gap between AY_f and BY_f, represented by AB.