Question

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

Answer 1

Excess demand is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. It implies two things-

1) Planned aggregate demand in the economy happens to exceed its full employment level.

2) The level of aggregate demand surpasses the level of aggregate supply even when the available factors are fully utilized.

Open market operation is the policy that focuses on increasing and decreasing the stock of liquidity with the people, through the sale and purchase of securities by the central bank. During excess demand or inflation, the central bank tries to sale securities. The sale of securities reduces purchasing power from the market. Consequently, aggregate demand is decreased and excess demand or inflationary gap gets combated.