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Question

Explain the situation of deficient demand in an economy. Also, explain the role of Repo Rate in correcting this.


Solution

Deficient demand refers to a situation wherein aggregate demand in the economy falls short of aggregate supply of goods and services at full employment. As a result, resources of the economy remain partly utilised indicating under-employment.

Impacts:

(i) Deficient demand leads to a fall in the income level, output and employment.

(ii) A persistent fall in deficient demand leads to a state of depression in the economy. 

Repo rate is the rate at which Central Bank gives loans to commercial banks. To correct the situation of deficient demand, the Central Bank will reduce the repo rate. This leads to a reduction in lending rates by the banks. Availability of cheaper credit increases the money supply and motivates the firms to borrow more for investment. Increase in investment demand would cause an increase in aggregate demand thereby eliminating the conditions of deficient demand.

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