Excess and Deficient Demand in 3 Sector Economy

What is 2 Sector Economy?

We have Studied that

AD=C+I

Aggregate Demand = Consumption Expenditure (of households) + Investment Expenditure (of firms)

Note

Here, we have assumed that there only 2 sectors of economy -

Households and Firms

What is 3 sector economy?

In this case, we assume that there are 3 sectors:

1. Households
2. Firms
3. Government

Hence,

Aggregate Demand = Consumption Expenditure (of households) + Investment Expenditure (of firms) + Government Expenditure

AD = C + I + G

Graph presentation

We know that

On X Axis, we present Income/Output

On Y Axis, we present Aggregate Demand

We can see that

Aggregate Demand is positively sloping starting from Point A

OA Represents Autonomous Expenditure

Now, if Aggregate Demand contains 3 sectors

AD Curve shifts upwards to AD'

This is because of Govt Expenditure

It can be seen that

AD Curve and AD' Curve are parallels to each other

This is because we assume Govt Expenditure also to be constant (it does not change with increase in income)

How is Equilibrium Point Determined in Case of 3 Sector Economy?

Just like in normal case

Equilibrium Point is determined at a point where

AD and AS Curve Intersect

On X Axis, we present Income or Output

On Y Axis, we represent Demand

It can be seen that

AD Curve is Positively sloping starting from Point A

AS Curve is also positively sloping starting from Origin (making 45 degree angle with Origin)

Both these curve intersect at Point E which is equilibrium Point

What happens in case of Excess Demand?

Just like in Normal Case

Excess Demand leads to inflationary gap

Inflationary gap is a situation where

Actual Aggregate Demand exceeds Aggregate Supply

at full employment level

Graph Presentation

We know that AD and AS Curve normally meet at Point E

Due to excess demand (AD Curve shifts upwards to AD' )

This leads to creation of Inflationary Gap (Represented by EF)

How is it corrected?

It is corrected by Government by reducing Govt Expenditure

It is done up to the amount of Inflationary Gap

This leads to decrease in Aggregate Demand

So AD Curve moves downward till it reaches the full employment equilibrium Point

What happens in case of Deficient Demand?

Just like in Normal Case

Excess Demand leads to deflationary gap

Deflationary gap is a situation where

Actual Aggregate Demand is less than Aggregate Supply

at full employment level

Graph Presentation

We know that AD and AS Curve normally meet at Point E

Due to excess demand (AD Curve shifts downwards to AD' )

This leads to creation of deflationary Gap (Represented by EF)

How is it corrected?

It is corrected by Government by Increasing Govt Expenditure

It is done up to the amount of Deflationary Gap

This leads to increase in Aggregate Demand

So AD Curve moves downward till it reaches the full employment equilibrium Point

NCERT Questions

No questions in this part

Other Books

Question 1

What is 3 sector economy?

Question 2

How does government correct excess demand in 3 sector economy?