Question

State and explain Keynes’ principle of effective demand.

Answer 1

Keynes’ Principle of Effective Demand states that the level of employment in an economy is determined by the point where aggregate demand equals aggregate supply, known as the point of effective demand. At this point, entrepreneurs maximize their expected profits by employing labor such that the expected proceeds from selling output just cover the costs of production. If aggregate demand falls short of aggregate supply, employment decreases; if it exceeds supply, employment rises until equilibrium is reached. Importantly, this equilibrium level of employment may be less than full employment when aggregate demand is insufficient to employ all available labor. The principle highlights that employment depends on demand-side factors and forms the core of Keynesian employment theory.