CBSE Class 12 Economics Demand Analysis Worksheet Set A

DEMAND ANALYSIS

Question. A situation when AS = AD along with fuller utilisation of resources in the economy is called:
(a) underemployment equilibrium
(b) inflationary gap
(c) equilibrium without excess capacity
(d) deflationary gap
Answer: C

Question. Aggregate demand can be increased by :
(a) increasing bank rate
(b) selling government securities by Reserve Bank of India
(c) increasing cash reserve ratio
(d) none of the above
Answer: D

Question. Aggregate demand can be decreased by :
(a) Rise in Bank Rate
(b) Purchase of securities in Open Market
(c) Deficit Budget
(d) Reduction in Tax burden
Answer: A

Question. In case of underemployment equilibrium:
(a) AS < AD
(b) there is excess capacity in the economy
(c) resources are not fully utilised
(d) both (ii) and (iii)
Answer: D

Question. Full employment:
(a) is consistent with ‘natural rate of unemployment’
(b) occurs when demand for labour force = supply of labour force
(c) AS = AD with zero level of unemployment
(d) both (i) and (ii)
Answer: D

Question. When aggregate demand is greater than aggregate supply, inventories
(a) fall
(b) rise
(c) do not change
(d) first fall, then rise
Answer: A

Fill in the blanks:

Question. ______ refers to a situation where AD falls short of AS at full employment.
Answer: Deflationary Gap

Question. When at the full employment level of income, AD exceeds AS, the difference is called _________ .
Answer: Excess demand,

Question. When aggregate demand is higher than aggregate supply at full employment, the gap is called __________.
Answer: Inflationary Gap

True or False:

Question. Full employment mean zero unemployment. 
Answer: False

Question. Voluntary unemployment occurs in the economy under deflationary gap.
Answer: False.

Question. Under employment implies voluntary unemployment.
Answer: False. 

Question. Excess demand raises the market value of output.
Answer: True.

Question. Match the following :

Answer: 1. (b) Fiscal Policy, 2. (d) Monetary Policy, 3. (a) Reduction is SLR, 4. (c) Selling of government securities

Short Answer Type Questions

Question. Explain the meaning of Deflationary Gap with the help of a diagram. 
Answer: Deflationary Gap refers to Aggregate Demand falling short of Aggregate Supply at the full employment level of income. It is called deflationary because it brings in deflationary tendencies. 

ADFE = Aggregate Demand at full employment level : ADIU = AD at involuntary unemployment level. The point E is equilibrium point, where AD = AS. But at the current, deficient demand due to involuntary unemployment of ADIU, the aggregate demand FP is less than actual supply in the economy. Hence, EF is Deflationary Gap.

Question. Give the meaning of :
(i) Involuntary Unemployment, and
(ii) Inflationary Gap.
Answer: (i) Involuntary unemployment exists when willing and able bodied people do not get employment at prevailing wage rate.
(ii) The excess of aggregate demand over aggregate supply at full employment is called inflationary gap.

Question. Explain the role of taxation in reducing excess demand. 
Answer: By raising taxes, government can reduce Personal Disposable Income of the people. This in turn will reduce private final consumption expenditure depending upon Marginal Propensity to Consume. This will reduce Aggregate Demand.

Question. Explain how controlling money supply is helpful in reducing Excess Demand.
Answer: Less money supply i.e., stock of money with people leaves less purchasing power in their hands. Therefore, people demand less goods and services, AD falls.

Question. Explain how can government spending be helpful in removing deficient demand.
Answer: Deficient Demand means excess of AS over AD at full employment. Since government expenditure is component of AD, increasing it will help in removing deficient demand in the economy.

Question. Define full employment in an economy. Discus the situation when aggregate demand is more than aggregate supply at full employment income. 
Answer: Full Employment is a situation where those who are able and willing to work are getting work at the prevailing wage rate.

Question. Define full employment in an economy. Discus the situation when aggregate demand is more than aggregate supply at full employment income.
Answer: Full Employment is a situation where those who are able and willing to work are getting work at the prevailing wage rate.
When Aggregate Demand is greater than Aggregate Supply at full employment, such a situation is known as Excess Demand or Inflationary Gap. It is called inflationary because this leads to a rise in general price level of the economy.

Question. Explain the role of bank rate in dealing with the problem of deficient demand. 
Answer: Bank rate is that rate of interest at which the central bank lends money to the commercial banks. In case of deficient demand there is a need to liberalize credit. It can be done by reducing bank rate so that the commercial banks also reduce their lending rate, thereby increasing the availability of credit in the economy.

Question. What is meant by inflationary gap? State three measures to reduce this gap.
Answer: Inflationary gap is the situation when AD exceeds AS corresponding to the full employment income level of income/output. Measures to reduce the inflationary gap are: (i) Decrease in Government Spending.
(ii) Increase in the level of taxes.
(iii) Increase in bank rate.

Question. Explain the role of margin requirements in dealing with the problem of excess demand. 
Answer: Margin requirement is the difference between amount of loan offered and the market value of security offered against the loan. Higher the margin requirement lesser will be the demand for loan. In this situation of excess demand there is a need to restrict loan/credit which can be done by raising the margin requirements.

Long Answer Type Questions

Question. Explain the meaning of Inflationary Gap and Deflationary Gap with the help of diagrams. 
Answer: Inflationary Gap occurs when AD > AS corresponding to full employment level. This inflationary gap, i.e., excess of aggregate demand causes inflation in the economy and price levels tend to rise.

In the above figure,
ADFE = AD at full employment level
ADAE = AD above full employment level
The point E is the equilibrium point where AD = AS. But the excess demand (current) of ADAE, aggregate demand FP is more than the aggregate supply in the economy. This difference of actual aggregate demand and supply i.e., EF is the Inflationary Gap. Inflationary Gap = Excess Demand = ADAE – ADFE = EF

Question. Distinguish between Inflationary Gap and Deflationary Gap. State two measures by which these can be corrected. 
OR
Explain the meaning of Inflationary Gap and Deflationary Gap. Explain any one measure by which these gaps can be reduced.
Answer: Inflationary Gap : When Aggregate Demand is greater than Aggregate Supply at full employment level, it is a situation of Inflationary Gap. 
Deflationary Gap : When Aggregate Demand is less than Aggregate Supply at full employment level. It is a situation of Deflationary Gap.
(i) Role of Open Market Operations in Correcting Deflationary Gap in an Economy : Open Market Operations refer to sale and purchase of securities by the Central Bank on behalf of government in the open market. It directly affects the supply of money in the hands of Commercial Banks and citizens of the country. In case of Deflation, the Central Bank purchase securities from public. It increases the supply of money in the economy and credit/money creation power of Commercial Banks. Thus, the Aggregate Demand increases and ultimately the economy attains equilibrium. 1 (ii) Role of Open Market operations in Correcting Inflationary Gap in an Economy : In case of Inflation, the Central Bank sell the securities to the public. It reduces the supply of money in an economy and credit / money creation power of Commercial Banks. Thus, the Aggregate Demand decreases and ultimately the economy attains equilibrium.
(iii) Role of Bank Rate in Correcting Inflationary Gap : The rate at which the Central Bank lends money to Commercial Banks is termed as Bank Rate. In case of inflation the Central Bank increases the bank rate to decrease the supply of money in the economy. Increase in bank rate reduces the money creation power of Commercial Banks and also increases the market rate of interest which discourages public to borrow loans.The Aggregate Demand comes down and the inflation is corrected. 1 (iv) Role of Bank Rate in Correcting Deflationary Gap : In case of Deflation, the Central Bank reduces the bank rate to increase the supply of money in the economy. Reduction in bank rate increases the money creation power of Commercial Banks and also decreases the market rate of interest which induces public to borrow more. The aggregate demand increases and the deflation is corrected.

Question. Explain all the changes that will take place in an economy when Aggregate Demand is not equal to Aggregate Supply.
Answer: Suppose AD is greater than AS. As a result, the producers find their inventories falling faster than expected. To maintain the inventory level, producers produce more. It starts rising and continues to rise till AD equals AS once again. 
Now, suppose AD is less than AS. As a result, the producers find that the inventories start going above the expected level. To bring down the inventories to the expected level, they start producing less. It starts falling and continues to fall till AD equals AS once again.

Question. What is ‘Deficient Demand’ ? Explain the role of ‘Bank Rate’ in removing it.
OR
Explain the Concept of “Deficient Demand” in macroeconomics, also explain the role of Bank Rate in correcting it. U [Delhi Set-I 2012]OR Explain the situation of deficient demand in an economy. Also explain the role of Repo Rate in correcting this.
Answer: A Situation in an economy, when the Aggregate Demand is less than the Aggregate Supply, corresponding to full employment level, is termed as deficient demand.
In the above figure, E is the equilibrium point of the economy where AD = AS. But at the present Aggregate Demand ADIU, gives AD equal to FP1 which is less than the Aggregate supply of EP1. Hence, EF represents the deficient demand in the economy. Deficient Demand gives rise to a deflationary gap and leads the economy to an equilibrium level of income/output that is less than the full employment level of income. This leads to deflationary pressures on economy and increases the inventory of producers as sales falls. The producers are discouraged to produce more as price level falls. The economy therefore will attain a new equilibrium at point G with National Income of OP. Role of Bank Rate in correcting the problem of Deficient Demand :
The rate at which the Central Bank lends money to commercial banks is termed as bank rate. In case of deficient demand, the Central Bank reduces the bank rate to increase the money supply in the economy. Reduction in bank rate increases the credit/money creation capacity of Commercial Bank and also reduces the market rate of interest which encourages people to borrow more. In this way, the AD increases to the level of AS and the economy attains equilibrium.

Question. The concept of “Deflationary Gap”. Also explain the role of “Margin Requirements” in reducing it. Explain this Statement and justify. 
Answer: Deflationary Gap refers to Aggregate Demand falling short of Aggregate Supply at the full employment level of income. It is called deflationary because it brings in deflationary tendencies. 3 Margin requirements refer to the discount on the security mortgaged by the borrower. It is determined by the Central Bank. In case of Deflationary Gap, the Central Bank reduces the discount so that the capacity to borrow is increased. This raises AD.

Question. What is ‘Excess Demand’ ? Explain the role of ‘Reverse Repo Rate’ in removing it. 
Answer: Excess demand refers to a situation when Aggregate Demand (AD) is in excess of Aggregate Supply (AS) corresponding to full employment in the economy. It causes Inflationary Gap in the economy. Price level tends to rise without any rise in the level of income or employment. Reverse Repo Rate : Reverse Repo Rate is the rate of interest at which Commercial Banks can park their surplus funds with the Central Bank, for short period. If Reverse Repo Rate is increased, then it is followed by increase in market rate of interest. Accordingly, cost of credit also increases. It will reduce flow of credit as desired.

Question. What is “Excess Demand” in Macroeconomics? Show the same in a diagram. Explain the role of Open Market Operations in reducing it.
Answer: Excess Demand : The situation in an economy, when Aggregate Demand is more than the Aggregate Supply corresponding to full employment, is termed as Excess Demand situation. In other words, the level of Aggregate Demand exceeds the level of Aggregate Supply even when there is full capacity production in the economy.
Here, ADFE = AD at full employment ADAE = AD at above full employment EF = Excess demand In the above figure, E is the point where AD = AS. i.e. equilibrium point. But at the current, Excess Demand of ADAE Aggregate Demand FP is more than the Aggregate Supply of EP. Hence, EF represents the Excess Demand in the economy. Excess Demand leads to reduction in inventories and inflation in the economy. High Prices encourage producers to produce more to reach the desired level of stock. Hence, the AS will also rise and economy will attain a new equilibrium at point G with National Income of OP’. 2 Role of Open Market Operations in Correcting Excess Demand : Open market operations refers
to sale and purchase of government securities by the Central Bank in open market. In case of excess demand, the Central Bank sells the securities to public. It reduces the supply of money and also reduces the credit creation power of Commercial Banks. In this way, the Aggregate Demand of economy comes down and the problem of excess demand is corrected.

Question. State whether the following statements are true of false. Give valid reasons for your answers. (i) Unplanned inventories accumulate when planned investment is less than planned saving.
(ii) Deflationary gap exists when aggregate demand is greater than aggregate supply at full employment level.
(iii) Average propensity to save can never be negative.
Answer: (i) True, as planned savings are more causing the Marginal Propensity to Consume to reduce thus Aggregate Demand will fall and producers will
have accumulation of inventory. (ii) False, Inflationary Gap exists when actual Aggregate Demand is more than Aggregate Supply corresponding to full employment level of output in the economy.
(iii) False, at income levels which are lower than break-even point, Average propensity to save can be negative as there will be dissaving in the economy.

Question. Explain the Concept of ‘Inflationary Gap’. Also explain the role of “Legal Reserves” in reducing it.
Answer: Inflationary Gap refers to the excess of Aggregate Demand over Aggregate Supply at full employment level of income. It is called Inflationary Gap because it brings in Inflationary tendencies. 3 Legal reserves refer to that part of bank deposits which Commercial Banks are legally required to keep in the form of cash partly with themselves (Statutory Liquidity Ratio) and partly with the Central Bank (cash reserve ratio). In case of Inflationary Gap, the Central Bank can increase the Legal Reserve Ratio (LRR) so that less money is available to the banks for lending. Borrowings are reduced. AD falls.

Question. State whether the following statements are true of false. Give reasons for your answers. (i) Inventories accumulate when planned investment is less than the planned saving. (ii) Inflationary gap exists when aggregate demand is greater than aggregate supply.
(iii) Average propensity to save can be negative.
Answer: (i) True, because I < S means AD < AS which will lead to accumulation of inventories. (ii) False, because inflationary gap exists when AD > AS at full employment. (iii) True, APS can be negative because AD can exceed AS upto a level of income.

Question. Explain the concept of Inflationary Gap. Explain the role of ‘Repo Rate’ in reducing the gap. 
Answer: Inflationary Gap : Inflationary gap is the excess of AD over and above its level required to maintain full employment equilibrium in the economy. Inflationary gap generates extra pressure on the existing flow of goods and services at the level of full employment. Accordingly, prices tend to rise. The output will not increase. Repo rate is the rate at which the Central Bank lends money to the Commercial Banks. To correct the situation of Inflationary Gap, Repo Rate is increased. As a follow-up action, the Commercial banks raise the market rate of interest (the rate at which the Commercial Banks lends money to the consumers and the investors). This reduces demand for credit. Consequently, consumption expenditure and investment expenditure get reduced. Implying a reduction in Aggregate .

I. Answer in one sentence each

a. Define demand

b. State law of demand.

c. Demand for good X decreases as price of good Y increases then the two goods are:

A. Absolute necessities    B. complementary good

C. inferior goods             D. Substitute goods

d. If a good is absolute necessity, then its price elasticity of demand is:

A. Zero       B. Unitary     C. Infinity    D. Inelastic

e. Draw a relatively inelastic demand.

II. Answer in around 60 words.

a. State law of demand. Explain with a schedule and diagram.

b. Consider two commodities Tea and Coffee. What could be the effect on demand for Tea if price of coffee falls. Explain with reason and suitable diagram.

c. Government declares a compulsory festival bonus of Rs.10000/- to all workers working in the country. Explain the likely impact on the demand for refrigerators in the country?

d. Distinguish between normal good and inferior good. Use examples.

e. Distinguish between complementary good and substitute good with examples.

f. Law of demand to holds good only under certain conditions. What are these?

III. Answer in around 75 words.

a. What does change in demand mean? Explain using diagram.

b. What does change in quantity demanded mean? Explain using diagram.

c. Define market demand curve. Explain with the help of a diagram.

d. Why does demand curve slope down ward? Explain the reasons behind this.

e. How is price elasticity of demand measured on a linear demand curve? Explain with the help of a diagram.

IV. Answer in around 100 words.

a. Define price elasticity of demand. State the meaning of five cases of price elasticity of demand with suitable diagram.

b. What are the important factors that influence price elasticity of demand for a good? Explain each

c. How is expenditure on a good by the consumer and price elasticity of its demand related When price of the good changes? Explain.

d. Explain the impact of demand for a good when:

i. Income of the consumer changes

ii. Price of related good changes

iii. Tate and preference of the consumer changes.

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