Question

How can the level of effective demand be raised for solving the problem of underemployment equilibrium?

Answer 1

The level of effective demand can be raised to solve the problem of underemployment equilibrium by increasing aggregate demand. According to Keynesian economics, equilibrium employment depends on the point where aggregate demand equals aggregate supply. Underemployment equilibrium occurs when this equilibrium is at a level less than full employment.

1. Increase Investment: Since consumption remains relatively constant in the short run, increasing investment is key to raising aggregate demand. Increased investment leads to higher demand for goods and services, which induces firms to employ more labor, thereby increasing employment from underemployment to full employment.
2. Increase Aggregate Demand: Aggregate demand can be increased by government spending, promoting private investment, increasing consumption through policies that boost income or reduce taxes, which results in an upward shift of the aggregate demand curve.