OUTPUT AND EMPLOYMENT

The equilibrium output in the economy also determines the level of employment, given the quantities of other factors of production (think of a production function at aggregate level). This means that the level of output determined by the equality of Y with AD does not necessarily mean the level of output at which everyone is employed.

Full employment level of income is that level of income where all the factors of production are fully employed in the production process. Recall that equilibrium attained at the point of equality of Y(Income) and AD by itself does not signify full employment of resources. Equilibrium only means that, if left to itself, the level of income in the economy will not change even when there is unemployment in the economy. The equilibrium level of output may be more or less than the full employment level of output.

If it is less than the full employment of output, it is due to the fact that demand is not enough to employ all factors of production. This situation is called the situation of deficient demand. It leads to a decline in prices in the long run. On the other hand, if the equilibrium level of output is more than the full employment level, it is due to the fact that the demand is more than the level of output produced at full employment level. This situation is called the situation of excess demand. It will lead to a rise in prices in the long run. 

Q) Excess demand is the situation where ......

Correct Answer: Demand is more than output level at full employment level.

Explanation:

To understand why this is the correct option, let us break down the concepts of equilibrium output, full employment, and excess demand step-by-step based on the provided text:

1. Equilibrium Output and Employment:
The equilibrium level of income or output ($Y$) is determined when aggregate output equals aggregate demand ($Y=AD$). This equilibrium point does not automatically guarantee that all resources or factors of production in the economy are fully utilized. The economy can settle at an equilibrium point that is either below, at, or above the full employment level of output.

2. Full Employment Level:
The full employment level of income represents the maximum potential output an economy can produce when all available factors of production (such as labor and capital) are fully and efficiently employed in the production process.

3. Defining Excess Demand:
According to the passage, if the equilibrium level of output tends to be greater than the full employment level, it is because aggregate demand exceeds the maximum capacity of the economy to produce goods and services at full employment. The passage explicitly states: "On the other hand, if the equilibrium level of output is more than the full employment level, it is due to the fact that the demand is more than the level of output produced at full employment level. This situation is called the situation of excess demand."

Therefore, excess demand corresponds directly to the situation where demand is more than the output level at full employment level, which eventually exerts upward pressure on prices, leading to inflation in the long run.