How to handle situations where the demands of a qualified applicant is higher than his / her qualifications & experiences?

Market situation has to be explained. Company's long term vision, integrity, ethics oriented have to be explained. The candidate has to be convinced stating that the company is offering non-monetary benefits of employee development trainings, medical insurance, life insurance etc., The company treats everyone equally, irrespective of nationality, culture, color, racism etc.,  

In most jobs advertisements salaries and compensations are usually specified, therefore applicant should already know about that, and if not hiring manager should clearly explain that to the candidate. If hiring manager really needs this applicant, he or she can make an offer !

I would explore further for character traits which could make the potential hire incredibly valuable to the job and team, but the job description did not or could not capture eg good sense of humour = ability to handle high pressure situations; interesting hobbies or lifestyle = innovative and creative problem solver etc. Then make it known on what considerations the job offer is being made , to introduce expectations management in a form that's respectful to both. This introduces a new pivot to hire a great new employee, or for both to walk away on good terms and actively keep in touch for a later hire.

A better quantitative performance managment sytem is the best answer to it. The negociater/Interviewer should convince the incumbent that initially we ll be offering this amount (approved) then the achievement of the KPI expectation will automatically be making your case stronger for a mid year increment.

It would be great if the Recruiter understands the candidate aspirations and the factors that motivated him to lookout for a change. He can match this with the company's offerings to the candidate like Good work life balance, Intangible benefits, Opportunity to learn, better career path and can help the candidate to accept the offer where the salary can be possible low.  

If you need the employee you should be flexible..

Its always better to make these admin issues clear at the onset of discussion. The candidate is to be taken to next level, only once the essential HR discussion has been taken care of.

1- First i will seek and source for those matching my criteria.

2- If i failed to find the qualified one, then i have2 options as next:

A) I reduce my criteria level to find new qualified candidates according to the new criteria.

B) I keep the criteria as it is, and choose the most qualified one and give him a training till he match our criteria level. 

I understand the question a bit differently: How to react if the candidate demands more compensation than he/she actually deserves, given his/her experience, qualifications, current market environment.

So, if someone overestimates his/her knowledge and/or negotiating power.

Right?

In the process of recruitment, there are two parties involved. recruiter and recruitee. Both party will be involved in a recruitment term negotiation simply put, buy and sell. Nowadays, we often encounter talents (recruitee) whom have much higher demands of employment terms and benefits disregarding their level of experiences and qualifications. This situation is basically a common trait of the human nature (Maslow's hierarchy of needs) to achieve a better quality of life. However, when dealing with this situation, a recruiter must also define the essence of employee benefits. Knowledge workforce today not only consider a better salary as a benefit but also prefer organizations with a great career path. Having an excellent succession planning program in place frequently will attract these talents to enroll. In addition, sharing the company's mission and vision with a candidate also have proven to be one of the best method in attracting newcomers to the company. 

I will ask applicant to justify his demand vis-a-vis the requirements of the job and the how he/she sees the market and his /her contributions that may be expected from him/her. this way applicant will not be offended.