Question

Explain the situation of deficient demand in an economy. Also explain the role of Repo Rate in correcting this.

Answer 1

Deficient demand refers to the situation when aggregate demand (AD) is less than the aggregate supply (AS) corresponding to 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 deflationary gap. Deflationary gap is the gap by which actual aggregate demand falls short of aggregate demand required to establish full employment equilibrium.
The concepts of deficient demand and defla­tionary gap are shown in Fig. 9.2. As seen in the diagram, income, output and employment are measured on the X-axis and aggregate demand is measured on the Y-axis. Aggregate demand (AD) and aggregate supply (AS) curves intersect at point E, which indicates the full employment equilibrium.
Due to decrease in investment expenditure (∆I), 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 deflationary gap. Point F indicates the underemployment equilibrium.
It may be noted that during deficient demand, equilibrium is determined at a level less than full employment equilibrium. It leads to underemployment equilibrium. In this situation, there exists involuntary unemployment.

Reasons for Deficient Demand:


The reasons for occurrence of deficient demand are almost opposite to the reasons for excess demand.
The main causes for deficient demand are:
1. Decrease in Propensity to consume:
A decrease in consumption expenditure, due to fall in the propensity to consume, leads to deficient demand in the economy.
2. Increase in taxes:
AD may also fall due to imposition of higher taxes. It leads to decrease in disposable income and, as a result, the economy suffers from deficient demand.
3. Decrease in Government Expenditure:
When government reduces its demand for goods and services due to fall in public expenditure, it leads to deficient demand.



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