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MEASURES TO CORRECT EXCESS
AND DEFICIENT DEMAND
BY
DEEPTHI THOMAS
An Overview Of The Topic
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Topic: Measures to correct excess and
deficient demand
What is excess demand?
What is deficient demand?
What are the measures taken?
Who should take the corrective measures?
How is it implemented?
What are the effects?
MEASURES TO CORRECT EXCESS AND
DEFICIENT DEMAND
There are four important ways to correct excess and
deficient demand
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Fiscal Policy
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Monetary Policy
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Foreign Trade Policy
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Other Measures
MEASURES TO CORRECT EXCESS AND
DEFICIENT DEMAND
FISCAL
POLICY
TAXATION
PUBLIC
BORROWING
PUBLIC
EXPENDITURE
BUDGET
MONETARY
POLICY
RESERVE
RATIO
BANK RATE
OPEN
MARKET
OPERATION
MARGIN
REQUIREMEN
T
MORAL
SUASION
DIRECT
ACTION
FOREIGN
TRADE
POLICY
IMPORT
SURPLUS
POLICY
EXPORT
SURPLUS
POLICY
OTHER
MEASUR
ES
WAGE
POLICY
FULL
UTILIZATI
ON OF
EXISTING
RESOURCE
S
FISCAL POLICY
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Policy of government relating to public expenditure, taxation and
management of public debt.
The policy adopted for correcting excess demand (inflationary
gap) and deficient demand (deflationary gap) is known as
counter cyclical fiscal policy.
Fiscal policy adopted to control inflation is called antiinflationary fiscal policy. Fiscal policy adopted during deficient
demand is known as anti-deflationary fiscal policy.
Classified into discretionary measures and non-discretionary
measures.
DISCRETIONARY MEASURES
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The measures which are adopted by the
government using its discretion and will.
The policy regarding public expenditure on road
construction, education, health care,
maintenance of law and order, defense of the
country, rural electrification, etc.
NON DISCRETIONARY
MEASURES
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It refers those in-built stabilizers of income which come
into operation automatically.
Progressive income tax and transfer payments like
unemployment allowance, old age pension, etc.
They are non-discretionary because they operate
automatically when economic activity goes upwards or
downwards.
TAXATION
Excess Demand: - By increasing taxes, the
purchasing power of people are reduced. This
will reduce aggregate demand and inflationary
pressure.
Deficient Demand:- In order to encourage
investment and consumption, taxes especially
corporate tax and income tax rates are reduced.
PUBLIC BORROWING
Public borrowing or public debt is the borrowing of the
public authorities.
Excess Demand: - Government borrows money from the
public. This will reduce purchasing power of the public
and hence aggregate demand will be reduced.
Deficient Demand: - In order to leave more money with
the public and to increase effective demand, government
will reduce size of public borrowing. It will also repay old
public debts during this period.
PUBLIC EXPENDITURE
Government demand is an important component of
aggregate demand.
Excess demand: - When government reduce its
expenditure during inflation, there will be reduction in
aggregate demand and hence in inflationary pressure.
Deficient demand: - During the time of deficient
demand, public expenditure on roads, defense, health
care, etc. will be increased. It will also increase transfer
payments like old-age pension, unemployment
allowances, etc. to increase effective demand.
SURPLUS AND DEFICIT BUDGET
Excess Demand: - During inflation, to reduce
aggregate demand, government will present surplus
budget. Surplus budget is that budget in which
government revenue is greater than expenditure.
Deficient Demand: - During deficit demand period,
government will present enlarged budget with huge
deficit. Deficit budget is the budget in which government
expenditure is greater than revenue. This will push up
demand.
MONETARY POLICY
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Any conscious action under taken by the monetary
authority (central bank) to change the quantity,
availability or cost of money.
To correct excess demand, the central bank follows antiinflationary monetary policy or ‘Dear Money Policy’
which is the policy that makes money dear or costly.
Monetary policy adopted during deficient demand is
known as anti-deflationary monetary policy or ‘Cheap
Money Policy’ which makes money cheaper by the
reduction of interest rate and by the availability of credit.
CASH RESERVE RATIO
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Member commercial banks are required under
the law to maintain a minimum percentage of
their demand deposit liabilities in the form of
cash with the Central Bank.
Commercial banks can lend only the remaining
portion of these deposits.
CASH RESERVE RATIO
Excess Demand: - The Central Bank increases this ratio,
which in turn reduces the lending capacity of the banks
and availability of credit.
Deficient Demand: - In order to expand credit the cash
reserve ratio, will be reduced. This will pump more
money into the economy which pushes up the economic
activity.
BANK RATE
Discount rate or bank rate is the rate at which the Central
Bank lends to the Commercial banks.
Excess Demand: -Central Bank raises bank rate. This will
make credit costlier. Interest rate will increase and
demand for credit will fall, which reduces the purchasing
power and effective demand.
Deficient Demand: - Rediscounting rate or bank rate will
be lowered in order to expand credit capacity of
commercial banks.
OPEN MARKET OPERATION
Buying and selling of government securities in the open
market by the Central Bank is known as Open Market
Operation.
Excess Demand: - Central Bank will sell these securities
in the open market.
Deficient Demand: - The Central Bank will purchase back
the securities from the market.
MARGIN REQUIREMENT
Margin requirement refers to the percentage of down
payment on borrowing to finance purchases of stock by
firms.
Excess Demand: -Margin requirements are fixed high.
This will discourage speculation on borrowed credit. It
will reduce inflationary pressure in the economy.
Deficient Demand: - Margin requirements are fixed low
during depression. This helps to pump more credit to the
economy.
MORAL SUASION
The Central Bank may issue advice, request and appeals to
member banks to co-operate with the credit policy of the
Central Bank.
Excess Demand: - Member banks are requested to
reduce the supply of credit.
Deficient Demand: - The Central Bank may issue advice,
request and appeals to member banks to expand credit.
DIRECT ACTION
As the last resort the Central Bank may take direct action
against member banks that are not fulfilling its credit
policy.
Excess Demand: - Direct action may be in the form of
refusing rediscounting facilities, charge in penal rate of
interest on loan issued, etc.
Deficient Demand: - The member banks that are not
fulfilling the credit expansion policy will be forced to
expand credit.
FOREIGN TRADE POLICY
The policy connected with import and export.
Excess Demand: -Import surplus policy may be adopted.
When import increases, the excess domestic purchasing
power may flow out to other countries which reduces the
intensity of domestic demand.
Deficient Demand:-Export surplus trade policy will be
followed. Export of more commodities will boost up the
demand for goods in country.
OTHER MEASURES
These are anti-inflationary measures
WAGE POLICY
During inflation, wage increase without improvement in
productivity may be avoided. During inflation, trade
unions will demand for wage increase. If wages are
increased without increase in productivity, it will cause
further increase in prices.
FULL UTILIZATION OF EXISTING
IDLE RESOURCES
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During inflation, measures may be adopted to
utilize the existing resources to its full capacity.
This measure is more useful to less developed
countries, where there are large amount of
under utilized resources.
CONCLUSION
These are the measures taken to control inflation and deflation
in India. Success of anti-inflationary and anti-deflationary
policies depends on several factors. It may not produce the
expected result always. However, earlier adoption of such
policies is necessary to prevent an economic crash.
References
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www.investopedia.com/articles/04/051904.asp
www.economicswebinstitute.org/glossary/pubex
p.htm
www.rbi.org.in/home.aspx
Systematic Approach To Economics
Dr. Thomas kutty, Dr. Anitha