How to Control/ Correct Excess Demand

Excess Demand can be controlled/corrected by using

Fiscal Policy

or

Monetary Policy

Fiscal Policy

These policies are framed by Central Govt

In this case, govt decides on following

Decrease in Govt Spending

(The govt spends less, demand for product decreases)

Increases Taxes

(Disposable income of people decreases and they are able to spend less)

Monetary Policy

These policies are framed by Central Bank (RBI)

Through these policy, RBI reduces amt of credit in circulation

Less the credit, less the amt of money in market so lesser will be demand

In this case, RBI does the following

RBI Increases Bank Rate and Repo Rate

Repo rate is the rate at which the RBI lends to commercial banks by purchasing securities 

while bank rate is the lending rate at which commercial banks can borrow from the RBI without providing any security.

When RBI increases Bank Rate and Repo Rate

banks have to pay more int on loan, so they will charge more from customers

So bank loans become expensive, people will take less loan so there will be less money in market

Less the credit, less the amt of money in market so lesser will demand

RBI Increases Cash Reserve Ratio/Statutory liquidity ratio

This leads to less amt available with banks to give loans

Less the credit, less the amt of money in market so lesser will demand

RBI does Open Market Operations

During excess demand, RBI sells its securities in market

Public subscribe to these securities

Hence less amt is available to them to spend

Less the amt of money in market so lesser will demand

Increase in Margin Requirement for Loan

As we know, banks gives loan only if we provide some security like offer some property for mortgage

Suppose Property Value is 100 lacs, bank will not give loan of 100 lacs

Suppose Margin as per Bank rule is 25%, it means Bank will give maximum 75 Lacs loan

Now if RBI Increases these margin requirement to 40%

So now if Property value is 100 lacs, Margin as per bank rule is 40%,it means maximum 60 Lacs loan is allowed

Less the amt of money in market so lesser will demand

Moral Suasion/Credit Rationing

RBI advices banks to not grant loans for certain sectors

Example: RBI may advice not to give loan for speculative activities or gambling

NCERT Questions

No questions in this part

Other Books

Question 1

Explain the role of bank rate in dealing with the problem of deficient demand?

Question 2

Discuss the role of government in correcting excess demand with the help of a diagram?