Question

To what extent does effective demand influence the level of employment in an economy?

Answer 1

Effective demand directly influences the level of employment because employment is determined where aggregate demand equals aggregate supply the point of effective demand. At this point, entrepreneurs maximize their expected profits and are willing to offer employment. If aggregate demand is higher than aggregate supply at a certain employment level, businesses will hire more workers; if lower, they will reduce employment.

However, the equilibrium at effective demand may correspond to less than full employment (underemployment). To reach full employment, effective demand must increase so that aggregate demand intersects aggregate supply at a higher level of employment. If aggregate demand increases beyond full employment, it leads to inflation rather than more jobs.

In short:

• Employment rises as effective demand increases.
• Employment falls if effective demand decreases.
• Effective demand determines equilibrium employment, but this need not be full employment.
• Full employment requires sufficiently high effective demand.

Thus, effective demand is the key factor governing how many people are employed in the economy.