Discuss the situation when aggregate demand is more than aggregate supply at full level of employmnet?

Question

Answer

Meaning:

When in an economy, aggregate demand is in excess of ‘aggregate supply at full employment’, the demand is called an excess demand.

Alternatively when aggregate demand exceeds ‘aggregate supply at full employment level the demand is said to be an excess demand and the gap is called inflationary gap. The gap is called inflationary because it causes inflation (continuous rise in prices) in the economy.

Inflationary Gap:

When aggregate demand is more than ‘level of output at full employment’, then the excess or gap is called inflationary gap. Alternatively ‘it is the amount by which actual aggregate demand exceeds the level of aggregate demand required to establish the full employment equilibrium.’ Thus, inflationary gap is a measure of the amount of excess of aggregate demand over ‘aggregate supply at full employment’.

In such a situation, an increase in demand means only an increase in money expenditure without any corresponding increases in output and employment because all the resources have already been fully employed. A simple example will further clarify it.

Answer

When aggregate demand is greater than aggregate supply at full employment  ,such situation is known as excess demand or inflationary gap. it is called inflationary because this leads to arise in general price level of the economy.

Answer

Introduction:
When aggregate demand exceeds aggregate supply at full employment, it creates a situation known as demand-pull inflation. This occurs when the total demand for goods and services in an economy surpasses the economy's capacity to produce them.

Causes of Aggregate Demand Exceeding Aggregate Supply:
There are several factors that can lead to a situation where aggregate demand surpasses aggregate supply at full employment:

1. Increased consumer spending: When consumers have more disposable income or confidence in the economy, they tend to spend more. This leads to an increase in aggregate demand.

2. Expansionary fiscal or monetary policies: Government actions such as increased government spending or reduced taxes can stimulate aggregate demand. Similarly, when central banks lower interest rates or increase the money supply, it encourages borrowing and spending, thereby increasing aggregate demand.

3. Exports exceeding imports: If a country experiences a surge in exports while its imports remain stable, it can result in increased aggregate demand.

Consequences of Aggregate Demand Exceeding Aggregate Supply:
When aggregate demand surpasses aggregate supply at full employment, several consequences may arise:

1. Inflation: The excess demand creates upward pressure on prices, leading to inflation. As businesses face increased demand, they may raise prices to maintain profitability. This can erode the purchasing power of consumers and reduce their standard of living.

2. Supply shortages: As demand exceeds supply, shortages can occur. This can lead to rationing, hoarding, or bidding wars for limited resources or goods, causing further price increases and economic instability.

3. Imbalance in the economy: Excessive demand in some sectors can lead to imbalances in the economy. For example, if there is a high demand for skilled labor but limited supply, wages in that sector may rise significantly, while other sectors experience slower wage growth or stagnation.

4. Reduced investment: When there is excess demand, businesses may struggle to meet the increased orders. This can deter investment as uncertainty about future demand levels makes businesses reluctant to expand capacity.

Conclusion:
When aggregate demand exceeds aggregate supply at full employment, it creates a challenging situation for the economy. Inflation, supply shortages, imbalances, and reduced investment are some of the consequences that can occur. Policymakers need to carefully manage aggregate demand through fiscal and monetary policies to maintain a stable and sustainable economy.

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