If the equilibrium level of output is less than the full employment o…

The correct answer is Option (1) → Deficient Demand.

Equilibrium only means that output equals aggregate demand; it does not mean that every factor of production is employed. If people demand less than the economy can produce with all its factors at work, firms produce only that much, and output settles below the full employment level. Because demand is not enough to employ all the factors, this is the situation of deficient demand.

Left to itself the economy can stay there with unemployment; in the long run deficient demand leads to a decline in prices.

Why the other options are incorrect

• Option (2) Aggregate Demand. — Incorrect. Aggregate demand is the total planned spending on final goods, C + I in the simple model; it is the quantity that falls short here, not the name of the situation.

• Option (3) Excess Demand. — Incorrect. Excess demand is the opposite case: equilibrium output is more than the full employment level, because demand is more than the output that can be produced at full employment, and it leads to a rise in prices.

• Option (4) Effective Demand. — Incorrect. The effective demand principle says that, with fixed prices and a perfectly elastic supply, output is determined by aggregate demand alone; it explains how equilibrium is reached, whether that equilibrium is below full employment or not.

Note: A same/similar question was asked in CUET (UG) in the papers below.

* A similar question.