Download Important Class 12 Macroeconomics Sandeep Garg Solutions Chapter 9 - Excess Demand and Deficient Demand Free PDF
FAQs on Sandeep Garg Class 12 Macroeconomics Chapter 9 Solutions
1. How do you correctly solve a problem that asks to explain the situation of 'Excess Demand' in an economy?
To solve a question on 'Excess Demand', you should follow these steps as per the CBSE 2025-26 guidelines:
- Define Excess Demand: Start by defining it as a situation where Aggregate Demand (AD) is greater than Aggregate Supply (AS) corresponding to the full employment level of output in the economy.
- Identify the Gap: State that excess demand leads to an inflationary gap.
- Explain with a Diagram: Draw a correctly labelled diagram showing the AD curve above the AS curve at the full employment equilibrium point (Yf). The vertical distance between the two curves represents the inflationary gap.
- State the Impact: Conclude by explaining the impact on the economy: there is no change in output or employment as resources are already fully utilised, but it leads to a persistent rise in the general price level (inflation).
2. What is the step-by-step method to explain how monetary policy measures are used to solve the problem of deficient demand?
To solve the problem of deficient demand (or a deflationary gap), the central bank implements an expansionary monetary policy. The correct method to explain this involves detailing the following measures:
- Bank Rate/Repo Rate: The central bank decreases the bank rate or repo rate. This lowers the cost of borrowing for commercial banks, encouraging them to borrow more and subsequently lend more to the public at lower interest rates, which increases Aggregate Demand.
- Open Market Operations (OMO): The central bank purchases government securities from the open market. This action injects liquidity into the banking system, increasing the lending capacity of commercial banks and boosting Aggregate Demand.
- CRR and SLR: The central bank reduces the Cash Reserve Ratio (CRR) and/or the Statutory Liquidity Ratio (SLR). This frees up more funds for commercial banks to lend, thereby increasing the money supply and encouraging spending and investment.
3. How should one correctly explain the use of fiscal policy instruments to solve the problem of an inflationary gap?
To correct an inflationary gap (caused by excess demand), the government uses a contractionary fiscal policy. The solution should be explained using the following instruments:
- Decrease in Government Spending: The government reduces its expenditure on public works, defence, infrastructure, etc. Since government spending is a direct component of Aggregate Demand (AD), a reduction in it directly lowers AD, helping to close the inflationary gap.
- Increase in Taxes: The government increases direct taxes (like income tax) or indirect taxes. This reduces the disposable income of households and the post-tax profits of firms, leading to a fall in consumption and investment expenditure, which in turn reduces AD.
4. What is the correct way to differentiate between an inflationary gap and a deflationary gap when asked in an exam?
When asked to differentiate, the solution should present a clear comparison based on key economic parameters. A complete answer would compare the two on the following basis:
- Meaning: An inflationary gap occurs when Aggregate Demand (AD) exceeds Aggregate Supply (AS) at the full employment level. A deflationary gap occurs when AD is less than AS at the full employment level.
- Economic Condition: The inflationary gap signifies excess demand, leading to inflation. The deflationary gap signifies deficient demand, leading to deflation and rising unemployment.
- Impact on Output: In an inflationary gap, real output does not increase as the economy is already at full employment. In a deflationary gap, output is lower than the potential full employment output.
- Equilibrium: The inflationary gap leads to an equilibrium level of income that is beyond full employment only in nominal terms. The deflationary gap leads to an underemployment equilibrium.
5. Why is simply stating "the central bank sells securities" an incomplete answer for solving how Open Market Operations (OMO) correct excess demand?
This statement is incomplete because it misses the crucial transmission mechanism, which is key to a full-marks answer. The correct, step-by-step explanation for solving the problem is:
- The central bank sells government securities in the open market.
- Commercial banks buy these securities, which leads to a transfer of funds from commercial banks to the central bank.
- This reduces the cash reserves and liquidity of commercial banks, thereby contracting their lending capacity.
- With less money to lend, commercial banks are forced to increase their lending rates.
- Higher interest rates make borrowing more expensive, which discourages both consumption and investment demand.
- This leads to a fall in Aggregate Demand, helping to close the inflationary gap.
6. How does the concept of the 'investment multiplier' from the previous chapter connect to solving the problem of a deflationary gap?
The connection is critical for determining the precise scale of intervention needed to solve a deflationary gap. While we know that increasing government spending (G) or investment (I) can close the gap, the investment multiplier (K) tells us by how much. The formula is ΔY = K × ΔI (or ΔG). This shows that the final increase in income (ΔY) will be a multiple of the initial injection of investment or spending. Therefore, to close a deflationary gap of, say, ₹1000 crore, the government doesn't need to increase spending by the full ₹1000 crore. It needs to calculate the required initial injection based on the value of the multiplier (which depends on the Marginal Propensity to Consume). Understanding this prevents policy overcorrection and is a crucial part of a comprehensive solution.
7. When solving problems, what is a common error in applying the 'Margin Requirement' as a tool to correct deficient demand?
A common error is to incorrectly state the direction of change or to provide a vague explanation. To solve the problem of deficient demand, the central bank must decrease the margin requirement. The correct, detailed solution is: The margin is the difference between the market value of the security offered for a loan and the amount of the loan granted. By reducing the margin (e.g., from 30% to 20%), the central bank allows borrowers to get a larger loan amount for the same value of collateral. This encourages more borrowing for investment and consumption, which in turn increases Aggregate Demand and helps correct the deflationary gap.
