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What will happen to an economy if aggregate demand falls below full employment level? Explain using a graph. Or Explain the role of margin requirement in correcting the problem of deflationary gap.

Answer:

 If aggregate demand falls below full employment level, it will lead to deflationary situations in the economy. Income/Output In this figure,                                                                                   = AD at full employment level                                                                                    = AD at involuntary unemployment level or below full employment level. The point E is the equilibrium point, where AD == AS. But at the current levels, deficient demand situation (due to involuntary unemployment) of                                                                                    , the Aggregate Demand is less than the actual supply in the economy. Hence, EF is the deflationary gap. Deflationary Gap = Deficient Demand =                                                                             =EF                                                        Or Margin requirement refers to the margin between the market value of the security provided by the borrower and the loan amount approved, When margin is lower, the borrowing capacity of the borrower is higher. The Central Bank has the power to change this margin. When Central Bank lowers the margin, the borrowing capacity of the borrower increases. This raises consumption expenditure and Aggregate Demand (AD) also increases which helps in correcting deflationary gap.