question_answer

The government of XYZ country is facing the problem of excess demand. The finance minister is comtemplating the option to increase the rate of taxation in the country. Will this help in solving the problem of excess demand?

Answer:

Excess demand refers to the situation when Aggregate Demand (AD) is in excess of Aggregate supply(AS), corresponding to full employment in the economy.                                        Income and employment AD and AS Curves In a situation of excess demand, government raises the rates of all taxes. This reduces the purchasing powder of the people and reduces both consumption and investment expenditures. A fall in consumption and investment expenditures reduces the level of aggregate demand and helps to check the problem of excess demand.