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Explain the concept of excess demand? in macroeconomics. Also explain the role of open market operations in correcting it.

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Explain the concept of 'deficient demand' in macroeconomics. Also explain the role of bank Rate in correction it.

 

Answer:

Concept of ?Excess Demand?: When the equilibrium level of income is determined after the level of full employment, it is the situation of excess demand. At the level of full employment, aggregate demand is more than aggregate supply. It leads to the high prices and it creates inflationary gap or excess demand.

Role of Open Market Operations to Correct Excess Demand: Open Market Operations refer to the buying and selling of securities either to the public or to the commercial banks in an open market. To curtail excess demand the central bank sells securities in the open market. By selling the securities in the open market the central bank withdraws excess money from the economy. This result in a lower Aggregate Demand in the economy and excess demand is controlled.

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Concept of ?Deficient Demand?: When the equilibrium level of income is determined before the level of full employment, it is the situation of deficient demand. In this situation aggregate demand is less than aggregate supply. It leads to the less production, rising unemployment level. All the resources will not be full employed at this level. This condition creates deflationary gap or deficient demand.

Role of Bank Rate to Correct Deficient Demand: Bank rate refers to the rate at which the central bank provides loans to the commercial banks. Thus to curtail deficit demand, the central bank lowers the bank rate. This implies that cost of borrowing for the commercial banks from the central bank reduces. The commercial banks in turn reduce the lending rate (the rate at which they provide loans) for their customers. This reduction in the lending rate raises the borrowing capacity of the public, thereby, encourages the demand for loans and credit. Consequently, the level of Aggregate Demand in the economy increases and deficit demand is corrected.