Open In App

Excess and Deficient Demand in Three-Sector Economy

Last Updated : 06 Apr, 2023
Improve
Improve
Like Article
Like
Save
Share
Report

Excess and Deficient Demand in Three-Sector Economy

When demand is more than what is necessary to utilise resources fully, it is called Excess Demand. However, when demand is not sufficient to fully utilise resources, it is referred to as Deficient Demand. Excess Demand and Deficient Demand can occur in a three-sector economy (which includes households, firms, and government). In a three-sector economy, Aggregate Demand (AD) is the sum total of Consumption (C), Investment (I), and Government Expenditure (G). Because of the introduction of the government sector, the new AD1 curve; i.e., C+I+G lies above the old curve AD; i.e., C+I. To make things simple, it is assumed that government expenditure is constant because of which the new AD1 curve is parallel to the old AD curve, as the vertical distance between them is G. 

The effect of Government Expenditure can be shown with the help of the following graph:

Effect of Government Expenditure

 

Note: Earlier, we discussed in excess demand and deficient demand that AD only includes Consumption and Investment. However, the inclusion of Government Expenditure does not have any impact on the nature or meaning of excess demand and deficient demand.

Remedy for Excess Demand and Deficient Demand

The government has taken different measures to correct the problem of excess and deficient demand in a three-sector economy.

Remedy for Excess Demand

The government can correct the problem of excess demand by reducing the aggregate demand by an amount, that is, equal to the inflationary gap.

Remedy for Excess Demand

 

In the above graph, F is the equilibrium point that is attained when the AD curve intersects the AS curve. To correct the problem of the inflationary gap, the government uses its fiscal measure and reduces expenditure. A reduction in government expenditure will reduce aggregate demand and remove the inflationary gap. Therefore, when there is a reduction in the government expenditure by \Delta{G}   the AD curve shifts downward to AD1. Now, the new aggregate demand level is AD1, which is sufficient enough to keep the economy at full employment equilibrium; i.e., point E.

Remedy for Deficient Demand

The government can correct the problem of deficient demand by increasing the aggregate demand by an amount that is equal to the deflationary gap. 

Remedy for Deficient Demand

 

In the above graph, F is the equilibrium point that is attained when the AD curve intersects the AS curve. However, the equilibrium point here signifies the underemployment equilibrium level and EG is the resulting deflationary gap. So, to correct this deflationary gap, the government uses its fiscal measure and increases expenditure. When the government expenditure is increased, the new aggregate demand level is AD1 which corresponds to a higher level of government expenditure. The new AD curve; i.e., AD1 is sufficient enough to keep the economy at full employment equilibrium; i.e., point E.


Previous Article
Next Article

Similar Reads

What is Fiscal Policy and how it used to correct Excess Demand and Deficient Demand?
Meaning of Fiscal Policy A fiscal policy is the policy of the central government which aims at controlling the situation of the money supply in the economy. Simply put, fiscal policy includes using taxation, government spending, and borrowing to change the level and growth of output, aggregate demand, and jobs. It is also used by the central govern
4 min read
Difference between Excess Demand and Deficient Demand
Excess demand and deficit demand are the two situations of disequilibrium. What is Excess Demand?When demand is more than what is necessary to utilise resources fully, it is called Excess Demand. In simple terms, when planned aggregate expenditure is more than aggregate supply at full employment, excess demand arises. It creates an inflationary gap
3 min read
What are the different measures to control Excess Demand and Deficient Demand?
When demand is more than what is necessary to utilise resources fully, it is called Excess Demand. In simple terms, when planned aggregate expenditure is more than aggregate supply at full employment, excess demand arises. However, when demand is not sufficient to fully utilise resources, it is referred to as Deficient Demand. In simple terms, when
11 min read
How to Control Deficient Demand?
Measures to control Deficient DemandWhen demand is not sufficient to fully utilise resources, it is referred to as Deficient Demand. In simple terms, when planned aggregate expenditure is less than aggregate supply at full employment, the situation of deficient demand arises. The problem of deficient demand arises when the current aggregate demand
6 min read
What is Deficient Demand?
According to Keynesian theory, an equilibrium income level might correspond to full employment, underemployment, or over the employment of resources. Similarly, when the economy is not at full employment, there will be instances of surplus demand and deficit demand. Excess demand and deficit demand are the two situations of disequilibrium. Meaning
4 min read
How to Control Excess Demand?
Measures to control Excess DemandWhen demand is more than what is necessary to utilise resources fully, it is called Excess Demand. In simple terms, when planned aggregate expenditure is more than aggregate supply at full employment, excess demand arises. The problem of excess demand arises when the current aggregate demand exceeds the aggregate de
6 min read
What is Excess Demand?
According to Keynesian theory, an equilibrium income level might correspond to full employment, underemployment, or over employment of resources. Similarly, when the economy is not at full employment, there will be instances of surplus demand and deficit demand. Excess demand and deficit demand are the two situations of disequilibrium. Meaning of E
4 min read
Difference between Formal Sector and Informal Sector
Informalisation of the Workforce is a situation where the workforce in the informal sector increases to the total workforce of the country. According to the composition of the workforce in India, it has been divided into two categories; Formal or Organised Sector and Informal or Unorganised Sector. The Formal Sector consists of jobs that have speci
3 min read
Difference between Public Sector and Private Sector Banks
The banking industry has been the backbone of our country's financial sector. Banks play an important role in the overall economic growth of the country. Public Sector Banks and Private Sector Banks are two of the three types of Commercial Banks (the third being Foreign Banks). [caption width="800"] [/caption]What are Public Sector Banks?Public Sec
4 min read
Difference between Open Economy and Closed Economy
Open Economy and Closed Economy play a very important part in understanding how nations interact within the global marketplace and how economic policies shape their development. An economy where international trade, investment, capital flows, etc., are encouraged is known as an Open Economy; whereas, an economy where activities that protect domesti
6 min read