Determinatio

n Of
Incom
e &
Employmen
t
 EXCESS
DEMAND
1.EXCESS Y
DEMAND A AD1
Excess Demand is S
E’ AD(FULL
a situation when Inflationary EMPLOYMENT)
AD>AS at full Gap Inflationary Gap is the gap
A
employment level. Actual AD is more than
when
D
E the
Required AD to establish
From Yf to Y*= Employment
Full
Monetary terms level.
45°
0 X
Y Y*
INCOME/OUTPUT/EMPLOYMENT
f
In the above diagram , Full Employment equilibrium is attained at point E, and
equilibrium level of income is Yf. Due to excess demand, AD curve shifts upward from
AD to AD1. New equilibrium is attained at point E’ with equilibrium level of income at
Y*.
Excess demand leads to Inflationary Gap.
 EXCESS
DEMAND
1.EXCESS Y
DEMAND A AD1
Excess Demand is S
E’ AD(FULL
a situation when Inflationary EMPLOYMENT)
AD>AS at full Gap
A
employment level. D
E
From Yf to Y*=
Monetary terms
45°
0 X
Y Y*
INCOME/OUTPUT/EMPLOYMENT
f
IMPACT:
1. Output: No change in Physical Output as all the resources of the economy are fully
and efficiently utilised.
2. Employment: No change, Economy at full employment
3. Price level: General Price level increases leading to Inflation.
 Causes of Excess
Demand(AD>AS)
Increase in Propensity to
Increase in consume
MPC
Decrease in Propensity to save
Increase in Disposable
Demand for Decrease Reductio Income,
Foreign produced in n in
Imports Taxes Increases Consumption
goods Decreases Demand

AD=C+I+G+(X-M)

Increase in
Demand for Increase in MEI OR
Increase in
Domestically Exports
Investment
Fall in Rate
produced goods Expenditur of Interest
Increases e
Increase in
Governmen
Increase in Public
t Demand for Goods
expenditure & Services
 DEFICIENT
DEMAND
2.DEFICIENT Y
A
DEMAND
Deficient Demand S AD=(FULL EMPLOYMENT)
is a situation in E
AD
which AD<AS at full 1 Deflationary Gap is the gap
A Deflationary
employment level. D
Actual
when AD is less than
E’ Gap the
Required AD to establish
Employment
Full
level.
45°
0 X
Y* Y
INCOME/OUTPUT/EMPLOYMENT
f

In the above diagram , Full Employment equilibrium is attained at point E, and

equilibrium level of income is Yf. Due to deficient demand, AD curve shifts downward
from AD to AD1. New equilibrium is attained at point E’ with equilibrium level of income
at Y*.
Deficient demand leads to Deflationary Gap.
 DEFICIENT
DEMAND
2.DEFICIENT Y
A
DEMAND
Deficient Demand S AD=(FULL EMPLOYMENT)
is a situation in E
AD
which AD<AS at full 1
A Deflationary
employment level. D E’ Gap

45°
0 X
Y* Y
INCOME/OUTPUT/EMPLOYMENT
f
IMPACT:
1. Output: Output falls due to insufficient AD.
2. Employment: This leads to the problem of Unemployment
3. Price level: General Price level decreases leading to
Deflation.
 Causes of Deficient
Demand(AD<AS)
Decrease in Propensity to
Decrease consume
in MPC
Increase in Propensity to save
Decrease in Disposable
Demand for Increase in Increase in Income,
Foreign produced Imports Taxes
Decreases Consumption
goods Increases Demand

AD=C+I+G+(X-M)

Decrease in
Demand for Decrease MEI OR
Decrease
Domestically in
in
Rise in Rate
Investment
produced goods Exports Expenditur of Interest
Decreases e
Decrease in
Decrease in Public
Governmen Demand for Goods
t & Services
expenditure
 MEASURES TO
CORRECT
The problem of Excess Demand and Deficient Demand can be corrected by the
following:
1. FISCAL POLICY
In this policy , government changes its revenue (Taxes) and Expenditure in order
to correct the measure.

2. MONETARY POLICY
In this policy , central bank (RBI) uses quantitative and qualitative measures to
correct
the situation.
 FISCAL POLICY
To correct Excess
1. Decrease in Government
Demand(AD>AS)
2. Increase in
Expenditure: Taxes:
Decrease in Increase in Taxes
Govt.
Expenditure

Decrease in
Production Decrease in
Disposable
Decrease in
Income
Income
generation
Decrease in
Decrease in
Income
Demand
distribution
Decrease in
Demand
 FISCAL POLICY
To correct Deficient Demand(AD<AS)
1. Increase in Government 2. Decrease in
Expenditure: Taxes:
Increase in Decrease in Taxes
Govt.
Expenditure

Increase in
Production Increase in
Disposable
Increase in
Income
Income
generation
Increase in
Increase in
Income
Demand
distribution
Increase in
Demand
 For For

BANK Loa
n
Loa
n Suppose
initial
bank rate=8%
RATE Public Commercial
Central Bank
(Lending rates
to
Bank public=10%)

Bank rate is the rate

at which central bank
lends money to the 10% 12%

commercial bank for Discouraged to

take
credit and Money
long term needs. supply
Central Bank Commercial Bank Public falls(to excess
correct
demand
)

6% 8%
Encouraged to
take credit and
Money
Supply
Central Bank Commercial Bank Public rises(todeficient
correct
demand
)
REPO For
Loa
n n
For
Loa
Suppose
initial
repo rate=8%
RATE Commercial
Lending rates
to
Public Central Bank public=10%
Bank
Repo rate is the rate
at which central bank
lends money to the 10% 12%

commercial bank for Discouraged

to take credit
short term needs. and Money
Central Bank Commercial Bank Public supply
falls(to
correct
excess
demand)

6% 8%

Encouraged to
take
credit and
Central Bank Commercial Bank Money
Public supply
rises(todeficient
correct
demand
)
REVERSE
For
REPO Commercial
Loan Central Bank
Bank
RA TE
Reverse Repo rate is the rate
at which commercial bank
lends money to the Central
bank. For
Commercial Bank parks Loan
money with Central Bank. Commercial
Central Bank
Bank
This instrument is generally
used to reduce the Money
Supply. So Increase in
Repo RateReverse
decreases Money
Cash reserves
Supply(to correct excess decrease and credit
demand). By lowering it raises availability
the cash reserve and money decreases
Commercial
supply(to correct deficient Bank Central Bank
demand)
 Sale of
OPEN MARKET Securities
(To correct Excess
OPERATIONS Demand
)

Open Market Operations(OMO)

refers to buying and selling of
government securities by the
Central Bank from/to the Central Bank
public and commercial banks.

Central bank reduces the

cash reserves of the
commercial banks and the Commercial
ability of create credit. Thus, Bank
Money Supply decreases.
 Purchase of
OPEN MARKET Securities
(To correct Deficient
OPERATIONS Demand
)

Open Market Operations(OMO)

refers to buying and selling of
government securities by the
Central Bank from/to the Central Bank
public and commercial banks.

Central bank increases the

cash reserves of the
commercial banks and the Commercial
ability of create credit. Bank
Thus, Money Supply
increases.
Cash Reserve
Ratio (CRR)
Rs.10
Rs.300 0
Reserves Central Bank
The percentage of total
Rs.20
deposits that the bank are Commercial 0
required to keep with the Bank
central bank in the form of
reserves is known as CRR. Rs.1000

Rs.700
With Increase in CRR(to Deposi
correct excess demand), more To the
t
reserves is to be kept with
RBI
which means less loans for Publi
the public. This leads to credit c
availability and money supply
falls. To correct deficient Public
demand CRR is
 Statutory
Liquidity
Ratio (SLR) Rs.10
0
Central Bank
Reserves Rs.300

The percentage of total

deposits that the central Commercial Rs.20
Bank 0
bank are required to keep
with themselves in the form Rs.1000
of reserves is known as SLR Commercial
Bank
Rs.700 Reserves kept
with
With Increase in SLR(to Deposi themselves
t To the
correct
excess demand),
reserves
more is to be kept with
Publi
RBI
which means less loans for
c
the public. This leads to credit
availability and money supply
falls. To correct deficient Public
demand SLR is
 For
Loan
Margin
Public Commercial
Requirement Bank

SSUUBBMT
I
It is the difference T (House paper
between the market value worth Rs.10
Public Collateral Lacs)
of the security and loan Public gets
given against it. discouraged to
take credit &
(House paper Money supply
Rs 6 falls
(to correct excess
worth Rs.10 Lac demand
Collateral Lacs) )
Supposedly,
Market Value of the Public gets
security=Rs.10 encouraged to
Lac
Loan amount= Rs. (House paper Rs. 9 take credit &
8Lac
Difference=Rs.2 Lac= Margin worth Rs.10 Lac Money supply
Collateral Lacs) rises
(to correct
Requiremen
t deficient
demand)
 SELECTIVE CREDIT
MORAL
RATIONING
SUASION
It refers to moral pressure on the
commercial banks. The central bank
requests or appeals to the
In this fixation of credit limits is
commercial banks to encourage or
done for different sectors of the
discourage credit. During Excess
economy.
During Excess Demand, the RBI
persuades Demand, RBI bank to
the commercial
implies credit rationing and during
discourage the public to take
Deficient Demand, the RBI withdraws
credit.
On the other hand, during
credit rationing.
Deficient
Demand , Commercial banks are
suggested to discourage the public to
take
credit.