The term deficient demand arises because of deficiency in AD (Aggregate demand ). When demand is lower than what is required for fuller utilization of resources then demand is term deficient. In order words, AD is deficient when it does not permit the fuller utilization of production capacity.AD is also deficient when the economy has excess capacity. According to Keynes, AD is deficient when it is less than AS corresponding to full employment in the economy.
Measurement of Deficient Demand
- Line start’s from the G point shows the required level of AD for full employment in the economy.
- B line shows planned AD which is lower than full employment AD
- The verticle difference between these lines is represented by EF and is termed deficient demand.
Causes of Deficient AD
In the below discussion we have divided causes as per closed economy and open economy. There are mainly two sectors which are responsible for the deficiency of AD in a two-sector closed economy. While in an open economy four sectors contribute to the advent of deficiency of AD.
Factors that causes deficient AD in two sectors closed economy :
Reduction in Private Consumption Expenditure(C)
Private consumption is an imperative element of AD. The reduction in private consumption will cause a deficiency in Aggregate demand. There would be several reasons for the reduction in private consumption expenditure. However, the most prominent reason is curtailment in the propensity to consume or increase in the propensity to save. In an advanced economics study, MPS (Marginal propensity to save) will rise when consumption reaches its peak. Let’s discuss the definition of MPS if you are not familiar. It is the ratio of additional saving (ΔS) to the additional income (ΔI).
Reduction in Private Investment Expenditure (I)
The other reason for the emergence of deficient demand is private investment expenditure. This factor will reduce because of poor business expectations. This situation arises during the years 2015- 16 in all the market economics of the world.
Factors that causes deficient AD in two-sector open economy :
Reduction in Government Expenditure (G)
Government has some budgetary constraints. As per the budget, they invest. The government can curtail its consumption expenditure or investment expenditure. Due to this reduction, the deficiency of demand arises in the economy.
The decline in Exports (X)
Export is a very important factor of growth in the economy. This is also an important component of AD. A drop in exports signifies a fall in expenditure on domestically produced goods and services. This circumstance arises the deficiency in demand.
Rise in Imports (M)
When international prices are lower than the domestic prices import will arise. We can say the import is the negative component of AD. Consequently, a hike in imports implies a drop-down in AD.
Increase in Tax Rates
The disposable income will be lesser if the Tax arises. A significant amount of habitants would go into the payment of tax. And people will be left with less disposable income. Due to this their capacity to spend will reduce, even when their propensity to spend remains the same.
Consequences of Deficient AD
The situation deficiency of AD leads to a problem for the producers. They are not able to fully utilize their resources (Production capacity ).In this circumstance planned output remains less than the potential output. As a result, underemployment equilibrium is struck in the economy. Accordingly, the Deficiency of AD generates underemployment equilibrium.
The other ramification due to deficiency of AD creates a ‘deflationary gap’ in the economy. This is the condition when a lack of demand leads to deflationary pressures in the economy. The impetus to invest is hurt. Low investment leads to low output. Implying low income, and low demand once again. Hence, the economy starts slipping into a ‘deflationary spiral or ‘low-level equilibrium trap’.
In a nutshell, when planned AD is lower than its full employment level it leads to the situation of deficiency of demand. It is depicted by a downward shift in AD function. So we conclude that deficient demand comes into existence because C, I, G and X elements of AD tend to drop, or when the M component tends to rise.