Question

How does effective demand determine the level of employment in the economy?

How does effective demand determine the level of employment?

Answer 1

Effective demand determines the level of employment at the point where aggregate demand equals aggregate supply. At this equilibrium point, entrepreneurs maximize expected profits and offer employment accordingly. If aggregate demand exceeds aggregate supply, employment will increase; if it is less, employment will fall. Thus, employment is determined by the intersection of aggregate demand and aggregate supply, which is the effective demand. However, this equilibrium level may not always correspond to full employment; higher effective demand is needed to reach full employment.