Question

State two important reasons by which excess demand is generated.

Hint:

Excess demand is generated by increased consumer spending and government fiscal policies that boost demand. If supply cannot match this demand, shortages and inflation may occur.

Answer 1

Step 1: Defining Excess Demand:
Excess demand occurs when the demand for goods and services exceeds the available supply at the prevailing price level. This condition leads to shortages, where consumers are unable to purchase all of the goods they desire, and may contribute to inflation as well. Excess demand can occur when the overall demand for goods in the economy grows faster than the economy's capacity to produce.
Step 2: Reasons for Excess Demand:
- Increased Consumer Spending: One of the most significant factors contributing to excess demand is an increase in consumer spending. This can occur when consumers experience a rise in income or when consumer confidence improves, leading them to spend more on goods and services. If this increased demand is not met by an increase in production, excess demand will occur, resulting in shortages.
For example, during a period of economic boom, people might spend more on durable goods, causing the demand for these goods to outstrip supply.
- Expansionary Fiscal Policies: When the government increases its spending or reduces taxes, it boosts aggregate demand in the economy. If the supply of goods and services does not increase at the same pace as this rise in demand, excess demand can arise. For instance, government spending on infrastructure projects or welfare programs may increase the purchasing power of consumers, driving up demand and leading to excess demand if the supply side doesn't keep up.
Step 3: Final Conclusion:
Excess demand is mainly generated by increased consumer spending, which may be fueled by rising incomes or enhanced confidence, and by expansionary fiscal policies, which increase government spending and reduce taxes, both of which drive up demand beyond the available supply.