question_answer

Define full employment in an economy. Discuss the situation when aggregate demand is more than aggregate supply at full employment income level.

Or

What are two alternative ways of determining equilibrium level of income? How are these related?

Answer:

Full employment: Full employment refers to a situation in which every able bodied person who is willing to work at the prevailing rate of wages is, in fact, employed.

Excess demand or Inflationary gap: when in an economy, aggregate demand is in excess of aggregate supply at full employment, the situation is termed as excess demand and the gap created is called inflationary gap.

For example: Let?s suppose on imaginary economy. Where by employing all of its available resources, can produce 10,000 qtls of rice. If aggregate demand for rice is, say 12,00 qtls, this demand will be called as excess demand and the gap between demand & supply is called inflationary gap.

The situation is shown through a graph:

In the graph. Point E lying on the \[45{}^\circ \] line is the full equilibrium point. This is an ideal situation because aggregate demand represented by EM is equal to full employment level of output represented by OM. The actual aggregate demand is for a level of output BM which is greater than full employment level of output EM (OM). Thus, the difference between the two is \[EB=BMEM\]which is measure of inflationary gap.

Or

Equilibrium level of income is that level of income at which aggregate demand equals aggregate supply. (And planned savings equals planned investment)

The two different alternatives to reach at the equilibrium level of income are:

(i) Increase in Govt. Expenditure to pump more money in the system to increase demand.

During the period of deficiency of demand, the Government should make large investments in public works like?construction of roads, bridges, buildings, railways, canals and provide free education and medical facilities although it may enlarge budget deficit. The aim is to give more money is the hands of people so that they should depend more.

(ii) Central bank should buy Govt. bonds and securities from commercial banks to increase cash stocks of banks for lending. By doing this money flow will increase in the economy. People will take loans from the banks to install new projects. More people will get jobs thus, income will increase, in turn, consumption will also increase and economy will move towards achieving equilibrium level of income.