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HOW TO SOLVE THE PROBLEM OF EXCESS DEMAND?

 Excess demand is basically a situation which arises when the aggregate demand is more than the aggregate supply that too when the economy is at full employment level. This means that the population is demanding more that the country can produce with all the resources available. This could happen due to many reasons like reduction in taxes, decrease in the imports, increase in the exports, increase in government expenditure and many more. Due to these reasons, the population holds more money power and therefore, demand more to raise their standard of living. During these times, the aim is to extract as much money from the population as possible so that their demanding power would decrease. So, how does the government control such a consequential matter. Here are the measures taken by the government.

 

FISCAL POLICY

 

1.DECREASE IN GOVERNEMNT SPENDINGS

Generally, the government spends a huge amount on the infrastructure and administrative activities. Although, during such a situation, they decrease these spendings so that they will have to pay less to the workers who are a part of the population and eventually it will lessen their money power. The government should usually reduce the expenditure on defence as they rarely contribute towards the growth of the economy.

 

2.INCREASE IN TAXES

Here, the government increases the rate of taxes and also tries to impose some new taxes. This is because they want to take away the extra money circulating in the economy so that their credit availability would be lowered, and they won’t be able to demand more than their need.

 

MONETARY POLICY

 

1.INCREASE IN BANK RATE

Bank rate is basically the rate at which the central bank lends money to the commercial bank to meet their long-term needs.  During this time, the central bank increases these rate so that the commercial banks wont have enough funds available with them to lend to the public and eventually, less money would be circulated in the economy.

 

2.INCREASE IN REPO RATE

Repo rate is the rate at which the central bank lends money to the commercial bank to meet their short-term needs. This also works as the same way, the banks won’t have enough funds to circulate to the public and the demand would decrease.

 

3.SALE OF SECURITIES

In the time of excess demand, the central bank offers securities to the commercial bank. In order to purchase these securities, the commercial banks will have to use their own money from their reserves which again will reduce their lending power and the public won’t be able to borrow much.

 

4.INCREASE IN LEGAL RESERVE RATIO (LRR)

The commercial banks are supposed to be maintaining a legal reserve. There are two types of these reserves, Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SRR). If these reserves would be increased then eventually the banks will have less money to lend forward to the people and hence, less money circulation in the economy.

 

5.INCREASE IN MARGIN REQUIREMENT

Margin requirement is the difference between the market value of the security offered and the value lent to them. During excess demand, the RBI increases this margin which does not allow the banks to lend extra to the public. Also, after an increase in this margin, the public is less interested in borrowing money.

 

6.ADVISE TO DISCOURAGE LENDING

During the excess demand, the central bank advises, requests or persuades the commercial banks not to lend money ahead for a speculative or any non-essential activity. This helps to reduce the money power among the population and eventually decrease the aggregate demand.