Class 12 Economics Chapter 7 Excess Demand and Deficient Demand

Chapter 7 of Class 12 Economics, titled “Excess Demand and Deficient Demand,” focuses on understanding what happens when an economy deviates from its full employment level of output. It explores the causes and consequences of excess and deficient demand, and how fiscal and monetary policies can be employed to restore equilibrium. The chapter is crucial for understanding how macroeconomic equilibrium can be disturbed and the steps taken to correct these imbalances.

What You Will Learn in Chapter 7 – Excess Demand and Deficient Demand

This chapter helps students identify the conditions that lead to an imbalance in aggregate demand and aggregate supply, known as excess or deficient demand. It explains how these imbalances affect output, prices, employment, and the overall stability of the economy.

Key Topics Covered:

Excess Demand (Inflationary Gap)

Definition: Occurs when aggregate demand > aggregate supply at full employment.
Features:
- No rise in output (beyond full employment).
- Results in demand-pull inflation.
Causes:
- Increase in consumption or investment.
- Rise in government spending.
- Increase in exports.
- Reduction in taxes.
Impacts:
- Inflation.
- Rise in input prices.
- Adverse balance of payments.
- Overheating of the economy.

Deficient Demand (Deflationary Gap)

Definition: Occurs when aggregate demand < aggregate supply at full employment.
Features:
- Fall in output and employment.
- Underutilization of resources.
Causes:
- Decrease in consumption or investment.
- Cut in government spending.
- Increase in taxes.
- Fall in exports.
Impacts:
- Unemployment.
- Low consumer confidence.
- Price fall or deflation.

Inflationary Gap vs Deflationary Gap

Basis	Inflationary Gap (Excess Demand)	Deflationary Gap (Deficient Demand)
Condition	AD > AS	AD < AS
Output Level	Beyond full employment	Below full employment
Main Problem	Inflation	Unemployment
Government Policy	Contractionary	Expansionary
Effect on Economy	Overheating	Slowdown

Government Policies to Correct Demand Gaps

Fiscal Policy Measures

To Correct Excess Demand:

Increase in taxes.
Reduction in government expenditure.
Creation of budget surplus.

To Correct Deficient Demand:

Reduction in taxes.
Increase in government expenditure.
Creation of budget deficit.

Monetary Policy Measures

To Control Excess Demand:

Increase
in repo rate and CRR.
Selling of government securities.
Reduction in credit creation by banks.

To Control Deficient Demand:

Decrease in repo rate and CRR.
Purchase of government securities.
Expansion of credit facilities.

Diagrams for Explanation

Inflationary Gap: AD curve intersects AS beyond full employment level.
Deflationary Gap: AD curve intersects AS below full employment level.

These diagrams help visualize the gaps in the economy and are often asked in board exams.

NCERT Solutions for Chapter 7 – Exercise Questions

Intext Questions:

Definition-based and conceptual understanding of inflationary and deflationary gaps.
Explanation of how aggregate demand shifts create these gaps.

Exercise Questions (Q1–Q10):

Step-by-step answers on:
- Causes of excess and deficient demand.
- Their economic effects.
- Role of monetary and fiscal policy.
- Conceptual questions with diagram-based explanations.
- Practical examples of inflationary and deflationary conditions.

Download Chapter 7 Solutions PDF – Excess Demand and Deficient Demand

Download our free, detailed PDF containing:

Complete solutions to all intext and exercise questions.
Labeled AD-AS diagrams.
Summarized notes and key points for revision.

Highlights of Our NCERT Solutions:

Well-explained policy tools to manage excess and deficient demand.
Diagram-based answers to enhance understanding.
Real-life examples of inflationary and deflationary trends.
Board-focused questions and answers aligned with CBSE pattern.

Recommended Preparation Tips:

Practice AD-AS diagrams showing both gaps.
Memorize fiscal and monetary tools used in both scenarios.
Focus on understanding the economic consequences of each type of demand gap.
Revise conditions of equilibrium and disequilibrium.
Attempt short and long-answer questions for both inflationary and deflationary gaps.

Additional Study Resources:

Chapter 7 Notes – Summary of Excess and Deficient Demand.
Flashcards: Terms like AD, AS, full employment, inflationary gap.
Exemplar Problems for deeper understanding.
MCQs and previous year questions for practice.

Mastering Chapter 7 – Excess Demand and Deficient Demand

Understanding this chapter is crucial for students who want to analyze how an economy reacts to demand fluctuations. From identifying gaps to applying corrective policies, mastering these concepts builds a strong foundation for macroeconomic policy-making.

Whether it\’s preparing for board exams or competitive tests, this chapter gives you essential insights into how economies are stabilized through strategic interventions.

NCERT Solutions for Class 12 Economics Chapter 7 Excess Demand and Deficient Demand

NCERT Textbook Questions Solved – Class 12 Macro Economics

Question 1. What is meant by excess demand in macroeconomics? [CBSE 2009]
Answer: When in an economy, aggregate demand exceeds aggregate supply at the full employment level, it is called excess demand.

Question 2. Define inflationary gap. [CBSE 2008]
Answer: Inflationary gap is the gap by which aggregate demand exceeds aggregate supply at full employment level.

Question 3. Give the meaning of deficient demand.
Answer: When aggregate demand falls short of aggregate supply at the full employment level, it is known as deficient demand.

Question 4. Define deflationary gap. [CBSE 2008, 2010]
Answer: Deflationary gap is the gap by which aggregate demand falls short of aggregate supply at the full employment level.

Question 5. State two measures by which a central bank can attempt to reduce the inflationary gap.
Answer:
1. Increase in cash reserve ratio (CRR)
2. Increase in margin requirements

Question 6. What is the impact of increase in margin requirements?
Answer: It discourages borrowings, leading to a decrease in aggregate demand.

Question 7. Give the meaning of full employment. [CBSE 2008]
Answer: Full employment is a situation where all able and willing persons willing to work at the prevailing wage rate are employed.

Question 8. Give the meaning of involuntary unemployment. [CBSE 2008, 2009, Sample Paper 2010]
Answer: Involuntary unemployment refers to a situation where people who are willing and able to work at the existing wage rate do not find employment.

Question 9. Is it necessary that equality between AD and AS is established at full employment level?
Answer: No, equilibrium can occur at under-employment, full employment, or over full employment levels.

Question 10. What is meant by full employment equilibrium?
Answer: It is a situation where aggregate demand equals aggregate supply at the full employment level.

Question 11. What is underemployment equilibrium? [CBSE 2008]
Answer: It refers to a situation where aggregate demand equals aggregate supply, but the level of employment is below full employment.

Question 12. What is the meaning of over full employment equilibrium?
Answer: It refers to a situation where aggregate demand equals aggregate supply at a level beyond full employment, leading to inflationary pressure.

II. Multiple Choice Questions (1 Mark)

Question 1. Name the situation where aggregate demand exceeds aggregate supply at full employment.
(a) Excess demand
(b) Excess supply
(c) Deflationary gap
(d) None of these
Answer: (a)

Question 2. Name the situation where aggregate demand falls short of aggregate supply at full employment.
(a) Excess demand
(b) Excess supply
(c) Inflationary gap
(d) None of these
Answer: (b)

Question 3. What is the impact of deficient demand on production and employment?
(a) Increase
(b) Decrease
(c) Remains constant
(d) None of these
Answer: (b)

Question 4. Fiscal policy measures to increase aggregate demand and control deficient demand include:
(a) Increasing government expenditure
(b) Reducing taxes
(c) A mix of (a) and (b)
(d) All of the above
Answer: (d)

Question 5. Fiscal policy measures to reduce aggregate demand and control excess demand include:
(a) Reducing government expenditure
(b) Increasing taxes
(c) A mix of (a) and (b)
(d) All of the above
Answer: (d)

Question 6. Monetary policy measures to increase aggregate demand and control deficient demand include:
(a) Reducing the bank rate
(b) Buying government securities
(c) Reducing CRR and SLR
(d) All of the above
Answer: (d)

Question 7. Monetary policy measures to reduce aggregate demand and control excess demand include:
(a) Increasing the bank rate
(b) Selling government securities
(c) Increasing CRR and SLR
(d) All of the above
Answer: (d)

III. Short Answer Type Questions (3-4 Marks)

Question 1. What are the reasons or causes for excess demand?
Answer:
1. Increase in household consumption due to higher propensity to consume.
2. Increase in private investment due to easy credit.
3. Rise in government expenditure.
4. Rise in export demand.
5. Increase in money supply or disposable income.

Question 2. What are the effects of excess demand on price, output, and employment?
Answer:
Effect on Price Level: Rises due to inflationary gap.
Effect on Output: No increase; economy is at full capacity.
Effect on Employment: No change; full employment already exists.

Question 3. What are the reasons or causes for deficient demand?
Answer:
1. Fall in household consumption due to low propensity to consume.
2. Decrease in private investment due to tight credit.
3. Reduction in government expenditure.
4. Fall in export demand.
5. Decrease in money supply or disposable income.

Question 4. What are the effects of deficient demand on price, output, and employment?
Answer:
Effect on Price Level: Falls, causing deflation.
Effect on Employment: Falls, leading to involuntary unemployment.
Effect on Output: Falls due to low investment and demand.

Question 5. Explain the role of Government expenditure and Open Market Operation in reducing AD/excess demand. [CBSE 2004C, 06, CBSE 2011; A 11]

(a) Government Expenditure:

Government incurs heavy expenditure on public works like roads, buildings, irrigation projects, etc.
During inflation, the government should reduce its spending on such public works to lower people\’s income and reduce their demand for goods and services.

(b) Open Market Operation:

It involves the buying and selling of government securities by the central bank in the open market.
In a situation of excess demand, the central bank sells government securities to commercial banks, reducing their capacity to offer loans and thus controlling excess demand.

Question 6. Differentiate between full employment and underemployment equilibrium.

Answer:

Full Employment Equilibrium: Occurs when aggregate demand equals aggregate supply at the full employment level of output.
Underemployment Equilibrium: Occurs when equilibrium is achieved below the full employment level, meaning some resources remain underutilized.

Question 7. What is meant by Margin Requirement? How does the Central Bank use this measure to control deflationary conditions in an economy? [CBSE Sample Paper 2016]

Answer:

Margin requirement is the difference between the value of security and the amount of loan granted against it.
To control deflation, the central bank reduces margin requirements, allowing borrowers to get more credit against their securities, thereby boosting demand.

IV. True or False

Are the following statements true or false? Give reasons.

To control deflation the central bank should increase the bank rate.
Answer: False. The bank rate should be decreased to make borrowing cheaper and boost demand.
Purchase of government securities by the central bank in the open market is an appropriate policy to check depression in the economy.
Answer: True. It increases liquidity and credit availability in the market, boosting demand.
To correct the deflationary gap, availability of credit should be increased.
Answer: True. More credit increases investment and consumption demand.
Fiscal policy has a direct effect on producing sector of the economy.
Answer: False. Fiscal policy affects all sectors, not just the producing sector.
Equilibrium below full employment level does not lead to fall in output level.
Answer: False. It leads to low output and investment due to insufficient demand.

V. Long Answer Type Questions (6 Marks)

Question 1. Explain the concept of underemployment equilibrium with the help of a diagram. Show on the same diagram the additional investment expenditure required to reach full employment equilibrium. [CBSE 2004]

Answer: Underemployment equilibrium is a situation where aggregate demand equals aggregate supply but at a level lower than full employment. It indicates that some resources remain unused.

Reasons for deficient demand:

Fall in consumption demand
Reduction in private investment
Decline in government expenditure
Decrease in exports
Fall in money supply or disposable income

To achieve full employment, additional investment equal to the deficiency in aggregate demand is required.

Question 2. Differentiate between inflationary gap and deflationary gap. Show deflationary gap on a diagram. Can this gap exist at equilibrium level? [CBSE 2004, AI 2013]

Answer: Yes, deflationary gap can exist at the equilibrium level. It is the shortfall of aggregate demand from the level of aggregate supply at full employment. The equilibrium occurs below full employment output.

Question 3. Explain the concept of Inflationary Gap. Explain the role of Repo Rate in reducing this gap. [CBSE 2015]

Answer: Inflationary gap is the excess of aggregate demand over aggregate supply at the full employment level.

Role of Repo Rate:

Repo rate is the rate at which commercial banks borrow from the central bank.
In case of inflation, the central bank increases the repo rate, making borrowing expensive.
This discourages banks from lending and people from borrowing, thus reducing demand and inflationary pressure.

Question 4. Explain the concept of Deflationary Gap and the role of ‘Open Market Operations’ in reducing this gap. [CBSE 2015]

Answer: Deflationary gap is the situation where aggregate demand is less than aggregate supply at full employment level.

Role of Open Market Operations:

Central bank buys government securities from commercial banks.
This increases banks\’ capacity to lend, which boosts demand and helps close the deflationary gap.

Question 5. What is ‘deficient demand’? Explain the role of ‘Bank Rate’ in removing it. [AI 2015]

Answer: Deficient demand arises when aggregate demand is less than aggregate supply at full employment.

Role of Bank Rate:

Bank rate is the interest rate at which the central bank lends to commercial banks.
To address deficient demand, the central bank reduces the bank rate.
This makes borrowing cheaper, encourages loans and investments, and increases consumption.

Question 6. What is ‘excess demand’? Explain the role of ‘Reverse Repo Rate’ in removing it. [AI 2015]

Answer: Excess demand is a situation where aggregate demand exceeds aggregate supply at full employment.

Role of Reverse Repo Rate:

Reverse Repo Rate is the rate at which RBI borrows from commercial banks.
To control inflation, RBI raises the reverse repo rate, encouraging banks to park their funds with RBI.
This reduces the money available for lending, controlling excess demand.

VI. Higher Order Thinking Skills

Question 1. It is necessary that the equilibrium level of national income is always at a full employment level. Explain this statement. [6 Marks]

Answer: Not necessarily. Equilibrium can occur at:

Full employment level – Ideal condition where all resources are utilized.
Over full employment level – Caused by excess demand, leading to inflation.
Underemployment level – Occurs when resources are not fully used due to deficient demand.

VII. Value Based Questions

Question 1. In Indian market, money supply is the reason of rising price level. Explain any one measure of central bank to control money supply. [3 Marks]

Answer: Central bank can increase:

Bank Rate
Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)

Question 2. Excess money supply is necessary for rapid economic development but it creates inflationary situation. Write any two fiscal measures to control inflationary situation. [3 Marks]

Answer:

Increase in tax rates
Reduction in public expenditure

Question 3. In India unemployment is a major problem, If aggregate demand is equal to aggregate supply, can it be called a situation of equilibrium? [1 Mark]

Answer: Yes, but it is called underemployment equilibrium where voluntary unemployment exists.

Question 4. Increase in money supply is an effective measure to control economic depression, but it creates the burden of borrowing on economy. Explain any two measures by which economic depression can be controlled even in the situation of increase in money supply. [3 Marks]

Answer:

Decrease in bank rate – makes borrowing cheaper, boosting investment.
Decrease in SLR – increases funds available for lending, stimulating demand.

VIII. Application Based Questions

Question 1. Depression is a high-handed monster, and if handled carefully it is not so troublesome. Comment. [3 Marks]

Answer: Depression causes slowdown in economic activities. However, appropriate fiscal and monetary policies can help recover from it. Past examples include the Great Depression of 1929 and the 2008–2012 global financial crisis.

Question 2. Small investors deposit their savings to sustain livelihood, but government reduces interest rates to boost the economy. This is inequitable. How? [3-4 Marks]

Answer:

Households rely on interest income to meet present and future expenses.
When interest rates fall, their returns decrease, affecting their livelihood.
However, lower interest rates encourage investment and boost economic growth.
There is a conflict between household income security and economic stimulus.