In This Post we are providing EXCESS DEMAND AND DEFICIENT DEMAND NCERT MOST IMPORTANT QUESTIONS for Class 12 BUSSINESS STUDIES which will be beneficial for students. These solutions are updated according to 2021-22 syllabus. These MCQS can be really helpful in the preparation of Board exams and will provide you with a brief knowledge of the chapter
NCERT MOST IMPORTANT QUESTIONS ON EXCESS DEMAND AND DEFICIENT DEMAND
1. Distinguish between inflationary gap and deflationary gap.
Ans. The excess of Aggregate Demand above the level that is required to maintain full employment level of equilibrium, is termed as inflationary gap. Inflationary gap causes inflation and increases wage and price levels in the economy.
When there is involuntary unemployment in the economy, there is a shortage in Aggregate Demand from the level required to maintain a full employment equilibrium. This short fall is termed as deflationary gap. Deflationary gap causes reduction in wage and prices in the economy.
2. Explain the concept of excess demand in macroeconomics. Also, explain the role of open market operation in correcting it.
Ans. The situation in an economy, when Aggregate Demand is more than the Aggregate Supply corresponding to full employment level is termed as excess demand. In other words, the level of Aggregate Demand exceeds the level of Aggregate Supply even when there is full capacity production in the economy.
In the above figure, £ is the point where AD = AS, i.e. equilibrium point. But at the present. Aggregate Demand ADae is more than the Aggregate Supply. Hence, EF represents the excess demand in the economy.
Excess demand leads to reduction in inventories and inflation in the economy. High prices encourage producers to produce more to reach the desired level of stock. Hence, the AS will also rise and economy will attain a new equilibrium at point G with National Income of OP.
Role of Open Market Operations to Correct the Problem of Excess Demand
Open market operations refer to sale and purchase of securities by the Central Bank on behalf of government in the open market. It directly affects the supply of money in the hands of citizens of the country. –
In case of excess demand, the Central Bank sells its securities to common public and financial institutions. It reduces the supply of money in the economy and reduces the money/credit creation power of commercial banks. Thus, the Aggregate Demand comes down and the economy attains equilibrium.
3. Explain all the changes that will take place in an economy when Aggregate Demand is not equal to Aggregate Supply.
Ans. (i) AD > AS When AD is greater than AS, flow of goods and services in the economy tends to be less than their demand. The existing stocks of the producers would be sold out. To rebuild the desired stocks the producer would plan greater production. AS would increase to become equal to AD.
(ii) AD < AS When AD is less than AS, flow of goods and services in the economy tends to exceed their demand. As a result, some of the goods would remain unsold. To clear unwanted stocks, the producers would plan a cut in production. Consequently, AS would reduce to become equal to AD. This is how AS adapts itself to AD
4. Explain the meaning of under employment equilibrium. Explain two measures by which full employment equilibrium can be reached.
Ans. In an economy, when AS = AD or S = I but without the fuller utilisation of labour force, the economy is said to be in under employment equilibrium.
Under employment equilibrium occurs when AS= AD but without the fuller utilisation of labour force.
Measures to Correct Under Employment Equilibrium
(i) Bank rate Central Bank should decrease the bank rate. A decrease in bank rate lowers the rate of interest and credit becomes cheap. Accordingly, the demand for credit expands and Aggregate Demand increases.
(ii) Open market operations By buying the government securities, the Central Bank injects additional purchasing power into the system which results in the expansion of credit. As a result Aggregate Demand increases.
5. Explain the concept of deficient demand in macroeconomics. Also, explain the role of bank rate in correcting it.
Ans. A situation in an economy, when the Aggregate Demand is less than the Aggregate Supply, corresponding to full employment level, is termed as deficient demand.
Deficient demand gives rise to a deflationary gap and leads the economy to an equilibrium level of income/output that is less than the full employment level of income. This leads to deflationary pressures on economy and increases the inventory of producers as sales falls. The producers are discouraged to produce more as price level fall. The economy therefore will attain a new equilibrium at point C with National Income of OP
Role of Bank Rate in Correcting the Problem of Deficient Demand
The rate at which the Central Bank lends money to commercial banks is termed as bank rate. In case of deficient demand, the Central Bank reduces the bank rate to increase the money supply in the economy. Reduction in bank rate increases the credit/money creation capacity of commercial banks and also reduces the market rate of interest which encourages people to borrow more. In this way, the Aggregate Demand increases to the level of Aggregate Supply and the economy attains equilibrium.
6. Explain the concept of deflationary gap. Also, explain the role of margin requirement in reducing it.
Ans. When there is involuntary unemployment in the economy, there is a short fall in Aggregate Demand from the level that is required to maintain a full employment equilibrium. This short fall is termed as deflationary gap.
Role of Margin Requirements to Reduce Deflationary Gap Margin requirement refers to the difference between the amount of loan granted and the current value of security offered for loans. In case of deflationary gap, the margin requirements are lowered to increase the flow of credit by encouraging people to borrow. As a result of that, the Aggregate Demand increases and ultimately the economy attains equilibrium.
7. Explain the role of the following in correcting deficient demand in an economy.
(i) Open market operations
(ii) Bank rate
Ans. (i) Role of open market operations in correcting deficient demand Open market operations refers to sale and purchase of securities by the Central Bank on behalf of government in the open market. It directly affects the supply of money in the hands of commercial banks and citizens of the country. In case of deficient demand, the Central Bank purchase securities from public.
It increases the supply of money in the economy as well as credit/money creation power of commercial banks. Thus, the Aggregate Demand increases and ultimately the economy attains equilibrium.
(ii) Role of bank rate In correcting deficient demand The rate at which the Central Banks lends money to commercial bank is termed as bank rate. In case of deficient demand, the Central Bank reduces the bank rate to increase the money supply in the economy.
Reduction in bank rate increases the money/credit creation power of commercial banks and also reduces the market rate of interest which encourages people to borrow more. In this way, the Aggregate Demand increases and ultimately the economy attains equilibrium.
8. Explain the role of the following in correcting excess demand in an economy
(i) Bank rate
(ii) Open market operations
Ans. (i) Role of bank rate in correcting excess demand The rate at which the Central Bank lends money to commercial bank is termed as bank rate. In case of excess demand, the Central Bank increases the bank rate to decrease the supply of money in the economy. Increase in bank rate reduces the money creation power of commercial banks and also increases the market rate of interest which discourages public to borrow loans. The Aggregate Demand comes down and the excess demand is corrected.
(ii) Role of open market operations in correcting excess demand Open market operations refer to sale and purchase of government securities by the Central Bank in open market. In case of excess demand, the Central Bank sells the securities to public.
It reduces the supply of money and also reduces the credit creation power of commercial banks. In this way, the Aggregate Demand of economy comes down and the problem of excess demand is corrected.
9. Explain the concept of inflationary gap. Also, explain the role of legal reserves in reducing it.
or
Define and represent inflationary gap on a diagram. Explain the role of the varying reserves requirement in removing the gap.
or
Explain the concept of inflationary gap. Use diagram. Also, explain the role of legal reserve ratio in removing the gap.
Ans. (i) Inflationary gap occurs when AD > AS corresponding to full employment level. This inflationary gap i.e. excess of Aggregate Demand causes inflation in the economy and price levels tend to rise.
(ii) Role of legal reserves to correct the problem of inflationary gap
Legal reserves like Cash Reserve Ratio and Statutory Liquidity Ratio are the tools to correct the problems of inflationary gap.
(i) Cash Reserve Ratio (CRR) Every commercial bank has to keep a certain proportion of its total demand and time deposits in the form of cash and other liquid assets with the Central Bank. This ratio is termed as cash reserve ratio. To correct the problem of inflationary gap the Central Bank increases the CRR. It reduces the supply of money and credit money creation capabilities of commercial banks. Due to lesser supply of money, the Aggregate Demand comes down and the economy attains equilibrium situation.
(ii) Statutory Liquidity Ratio (SLR) It refers to a fixed percentage of the total assets of a bank in the form of cash or other liquid assets that is required to be maintained by the bank with themselves. During the situation of inflationary gap, SLR is increased. This reduces the credit creation capacity of commercial banks and reduces the flow of money in the economy. As a result of that, the Aggregate Demand comes down and ultimately the economy attains equilibrium again.
10. Explain the meaning of equilibrium level of income. Can there be an unemployment in the economy at an equilibrium level of income? Explain.
Ans. Equilibrium level of income is the level at which Aggregate Demand is equal to Aggregate Supply in the. economy i.e. AD = AS. In other words, when desired output equals desired expenditure , equilibrium output or income is attained.
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