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What is Deficient Demand?

Last Updated : 06 Apr, 2023
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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 of Deficient Demand

When 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. It creates a deflationary gap. The deflationary gap is the difference between actual aggregate demand and the demand necessary to achieve full employment equilibrium. In short, the country’s overall demand is below what is necessary to keep it at full employment. A deflationary gap leads to a decline in the economy’s income, output, employment, and price level, driving the economy into a state of underemployment. Thus, deficit demand results in deflation.

Deficient demand refers to the situation when Aggregate Demand (AD) is short of Aggregate Supply (AS) corresponding to full employment in the economy, i.e., AD<AS. 

OR

When AD is less than required/ planned AD to maintain full employment.

Deficient Demand and Deflationary Gap

 

The above figure illustrates the concepts of deficit demand and the deflationary gap. As shown in the diagram, aggregate demand is shown on the Y axis, while income, output, and employment are shown on the X axis. The intersection of aggregate demand and supply, or point E, represents the full employment equilibrium. A reduction in investment expenditure (\Delta{I})   causes the aggregate demand to drop from AD to AD1. It describes a situation when there is deficit demand, and the difference between them, or EG, is known as a deflationary gap. The underemployment equilibrium is shown at Point F.

Reasons for Deficient Demand

1. Decrease in Private Consumption Expenditure (C): 

Private consumption expenditures are a significant part of Aggregate Demand. A serious deficiency in Aggregate Demand results from a decrease in private consumption expenditures. Spending on private consumption may reduce for several reasons. But, the propensity to consume or a growth in the propensity to save is the most crucial factor. Deficient demand in the economy results from a decline in consumer spending due to a decrease in the propensity to consume.

 2. Decrease in Private Investment Expenditure (I): 

Private consumption expenditure is another significant part of Aggregate Demand. It may be reduced in instances where company expectations are low. In the years 2020–2021, it took place in all market economies around the world. 

 3. Decrease in Government Expenditure (G): 

The government may reduce its investment or consumption expenditure. This could occur as a result of government budget restrictions. Aggregate Demand is decreased when the government or investment expenditure is reduced.

4. Decrease in Exports (X):

Exports refer to transferring of domestically produced goods to another country. A decrease in exports indicates a decrease in expenditure on domestically produced products and services. This causes a decline in demand.

5. Increase in Imports (M):

When domestic prices are higher than those on the international market, imports may increase. Imports are a negative factor in Aggregate Demand. As a result, an increase in imports causes a decrease in aggregate demand.

6. Increase in Tax Rates:

People have less disposable income because of an increase in tax rates. Even while their tendency to spend stays the same, it lowers their capacity to spend. Reduced disposable income leads to lower aggregate demand.

Impact of Deficient Demand

Due to its deflationary effect, insufficient demand causes numerous problems for the economy. Deficient demand typically has a negative impact on the economy’s level of output, employment, and price level.

1. Impact on Output: 

There will be an increase in inventory stock due to a lack of sufficient aggregate demand. The businesses will be compelled to plan for lower production within the following time frame. The anticipated output will therefore decrease.

2. Impact on Employment: 

As the level of investment decreases in the economy, there is a decrease in the anticipated output. It reduces the level of employment in the country. Thus, deficient demand leads to involuntary unemployment in the economy.

3. Impact on the General Price Level: 

Due to a lack of demand for goods and services in the economy, deficient demand leads general prices to decline. The prices tend to decrease, which leads to deflation.


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