UNIT – 3

DETERMINATION OF INCOME
AND EMPLOYMENT
-PROBLEMS OF DEFICIENT DEMAND
AND EXCESS DEMAND
 DEFICIENT DEMAND
• Deficient demand refers to the situation when aggregate demand (AD) is short of aggregate
supply (AS) corresponding to full employment in the economy.
AD < AS : corresponding to full employment
• Due to deficient AD, equilibrium between desired AD and desired AS is struck at a level lower
than full employment in the economy. This is a situation of underemployment equilibrium.
The following figure illustrates the situation of deficient demand and underemployment
equilibrium:
 DEFLATIONARY GAP AND ITS MEASUREMENT
• Deficient demand is a situation of underemployment equilibrium. It is a situation when resources are not fully
utilised and there is excess capacity in the economy. The economy tends towards a situation of deflation. Such
situation is known as deflationary gap.
• So, deflationary gap is the shortfall in AD from the level required to maintain full employment equilibrium in
the economy. In such a situation, there is involuntary unemployment in the economy.
• Deflationary gap is measured as the difference between ‘desired AD corresponding to full employment’ and
‘desired AD corresponding to underemployment’. Following diagram shows the deflationary gap:

In the diagram, GK is the deflationary gap.

So,

Deflationary Gap = Deficient Demand

= ADF - ADU = GK
 EXCESS DEMAND
• Excess demand refers to the situation when aggregate demand (AD) is in excess of aggregate supply (AS)
corresponding to full employment in the economy.
AD > AS : corresponding to full employment
• Due to excess AD, equilibrium between desired AD and desired AS is struck at a level higher than full
employment in the economy. Since resources have already been fully utilised, therefore aggregate supply
cannot be raised. Further demand implies pressure on the available goods and resources in the economy,
hence prices of goods and services tends to rise.
The following figure illustrates the situation of excess demand:
 INFLATIONARY GAP AND ITS MEASUREMENT
• In a situation of excess demand, the level of output does not rise because factors of production are already
fully employed.
• Output level remains constant corresponding to full employment. Only prices tends to rise. Since economy
tends towards inflation, this situation is called inflationary gap in the economy.
• So, inflationary gap is the excess of AD over and above its level required to maintain full employment
equilibrium in the economy.
• Inflationary gap is measured as the difference between ‘AD beyond full employment’ and ‘AD at full
employment’. Diagram show the details:
So,

Inflationary Gap = Excess Demand

= ADE - ADF = CF
THANK YOU