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Question
Which of the following points are related with effective demand?
Options
Effective demand refers to a situation in which equilibrium output is determined solely by the level of aggregate demand.
The supply is infinitely elastic and if there exists an inequality between the Aggregate Demand (AD) and the Aggregate Supply (AS), then the equilibrium output will only be influenced by AD.
Both Effective demands refer to a situation in which equilibrium output is determined solely by the level of aggregate demand and The supply is infinitely elastic, and if there exists an inequality between the Aggregate Demand (AD) and the Aggregate Supply (AS), then the equilibrium output will only be influenced by AD.
None of the above
Solution
Both Effective demands refer to a situation in which equilibrium output is determined solely by the level of aggregate demand and The supply is infinitely elastic, and if there exists an inequality between the Aggregate Demand (AD) and the Aggregate Supply (AS), then the equilibrium output will only be influenced by AD.
Explanation:
The phrase "effective demand" describes a situation in which the level of aggregate demand is the only determinant of equilibrium production. This is because the supply is assumed to be infinitely elastic, and if the aggregate demand (AD) and aggregate supply (AS) are unequal, the equilibrium output will only be changed by AD. With the help of the diagram shown, the concept of effective demand can be described.
The x-axis depicts the level of income/output, while the y-axis depicts aggregate demand. The place where the two curves AS and AD meet is called E. The output level is governed by AD (assuming supply elasticity is completely elastic) and EG is the effective demand.
The autonomous expenditure multiplier is calculated as follows:
Y = AD (at equilibrium)
Y = A + cY [Where AD = A + cY]
Y − cY = A
Y (1 − c) = A
Y = `"A"/(1 - "c")`
Where
A = Autonomous expenditure
c = MPC
Y = level of income
`1/(1 - "c")` = autonomous expenditure multiplier
So, the autonomous expenditure multiplier is dependent on the income and MPC