Question

Define excess demand. Explain with diagram.

Answer 1

Excess Demand: When the planned aggregate expenditure is greater than the available output at full employment level, the situation is termed as excess demand. It leads to an inflationary gap in the economy.

Inflationary Gap: When aggregate demand is more than the level of output at the full employment level, then the gap is called inflationary gap.

As can be seen in the diagram, $O{Y}_F$ is full employment level at which $E{Y}_F$ is full employment aggregate demand but the actual aggregate demand is $F{Y}_F.$ So, FE is the excess demand which creates the inflationary gap.