Effective Demand

In modern macroeconomics, the principle of effective demand is very important for explaining how much employment exists in an economy.
Economist Dillard said that the logical starting point of Keynes’ theory of employment is this principle of effective demand.

• "The value of D (Aggregate Demand) at the point of aggregate Demand function where it is intersected by Aggregate Supply function will be called, the Effective Demand." — J.M. Keynes
• "It is that demand price which becomes effective because it is equal to aggregate supply price and thus represents a position of short run equilibrium." — Stonier and Hague
• "The adjective effective is used to designate the point on the aggregate demand curve where it is intersected by the aggregate supply curve." -Dillard

Before Keynes, some economists had already discussed the idea of effective demand.

• The classical economist T.R. Malthus and the neo‑classical economist Wicksell had both put forward the concept of effective demand in some form.
• However, it was Lord Keynes who first clearly used the term demand in the sense of effective demand at different levels of employment and made it central to his theory.

Because of this, effective demand occupies a central place in the Keynesian Theory of Income and Employment.

In simple words, effective demand refers to the total (aggregate) demand in the economy at different levels of employment.
Keynes used the word “effective” to show that this is not just any demand, but the level of aggregate demand which, together with aggregate supply, actually determines the level of employment in the economy.

So, in the Keynesian system:

• Aggregate demand and aggregate supply together decide the equilibrium level of employment.
• The level of employment that is actually realised at this equilibrium is called the level of effective demand.

• Effective demand is the aggregate demand in the economy at different levels of employment.
• Keynes used the term “effective demand” to describe that level of aggregate demand which, along with aggregate supply, determines the actual level of employment.
• The principle of effective demand is the starting point of Keynes’ modern theory of employment.
• Earlier economists like Malthus and Wicksell discussed the idea, but Keynes gave it a clear and central role in his theory.