Question

How does excess demand affect output, employment, and prices in an economy?

Answer 1

Excess demand occurs when aggregate demand exceeds aggregate supply at full employment level. Output does not increase because the economy is already at full employment and resources are fully utilized. Employment remains unchanged as full employment is already achieved. Excess demand creates additional pressure on existing goods and services, leading to shortages. This shortage pushes prices upward, causing inflation. The increase in prices is proportional to the rise in demand beyond full employment. Hence, excess demand leads to inflationary pressures but does not increase output or employment. This situation is called an inflationary gap in economics.