- Determines employment: Level of employment depends on effective demand; unemployment is due to its deficiency.
- Rejects Say’s Law: Income does not automatically create equal demand.
- Refutes wage-cut theory: Wage cuts reduce demand and employment.
- Highlights role of investment: Employment rises only when investment increases.
- Explains paradox of poverty: Unemployment can exist even with abundant resources due to low demand.
Definitions [3]
Definitions: Effective Demand
- "The value of D (Aggregate Demand) at the point of aggregate Demand function where it is intersected by Aggregate Supply function will be called, the Effective Demand." — J.M. Keynes
- "It is that demand price which becomes effective because it is equal to aggregate supply price and thus represents a position of short run equilibrium." — Stonier and Hague
- "The adjective effective is used to designate the point on the aggregate demand curve where it is intersected by the aggregate supply curve." -Dillard
Definitions: Aggregate Demand Function
- "The aggregate demand price for the output of any given amount of employment is that total sum of money or proceeds which is expected from the sale of the output produced when that amount of labour is employed." — Dudley Dillard
- "The aggregate demand price at any level of employment is the amount of money which all the entrepreneurs in an economy taken together really do expect that they will receive if they sell the output produced by this given number of men." — Stonier and Hague
- "Aggregate Demand Function is a schedule of the various amounts of money which the entrepreneurs in the economy expect from the sale of their output of various levels of employment." — Peterson
Definitions: Aggregate Supply Function
- "At any given level of employment of labour, aggregate supply price is the total amount of money which all entrepreneurs in the economy, taken together, must expect to receive from the sale of the output produced by that given number of men, if it is to be worthwhile employing them." — Stonier and Hague
- "Aggregate supply price of the output of given amount of employment is the expectation of proceeds which will just make it worthwhile for the entrepreneurs to give that employment." — J.M. Keynes
Formulae [2]
Formula: Aggregate Demand Function
- Symbolic Function: D = f(N) (where D is demand/receipts and N is employment).
- Components of AD: AD = C + I + G + (X - M).
C: Household Consumption.
I: Private Investment.
G: Government Demand.
(X - M): Net Exports (Exports minus Imports).
Formula: Aggregate Supply Function
\[Z=\phi(N)\]
Where Z denotes the aggregate supply price of the output
N = Level of employment offered by entrepreneurs, and ϕ stands for the functional relation between Z and N.
Key Points
Key Points: Effective Demand
- Effective demand is the aggregate demand in the economy at different levels of employment.
- Keynes used the term “effective demand” to describe that level of aggregate demand which, along with aggregate supply, determines the actual level of employment.
- The principle of effective demand is the starting point of Keynes’ modern theory of employment.
- Earlier economists like Malthus and Wicksell discussed the idea, but Keynes gave it a clear and central role in his theory.
Key Points: Determinants of Effective Demand > Aggregate Demand Function
- Effective Demand: Determined by two functions: Aggregate Demand (AD) and Aggregate Supply (AS).
- AD Definition: The total sale proceeds entrepreneurs expect to receive from selling output produced at a specific employment level.
- The AD Curve: It starts above the origin (Point P) because Autonomous Consumption is always positive, even if income is zero.
- Employment Link: Higher employment leads to more output and higher expected receipts, but the rate of increase eventually slows down.
- Keynes' Consumption Rule: As income rises, consumption also rises, but not by the same amount as the income increase.
Key Points: Determinants of Effective Demand > Aggregate Supply Function
- Definition: ASF shows the minimum money entrepreneurs must expect to receive from sales to justify hiring a specific number of workers.
- Relationship: It establishes a functional relationship where aggregate supply (Z) depends on the level of employment (N), expressed as Z = \[\phi\](N).
- Increasing Function: As the level of employment rises, the minimum receipts required by producers also increase.
- The Limit (Full Employment): The curve rises until it reaches the point of "Full Employment" (Point K), after which it becomes vertical (inelastic).
- Variable Shapes: The curve is linear if wages are constant, but becomes curvilinear if wages increase as more people are hired.
Key Points: Determination of Effective Demand
- Effective demand is determined at the point where Aggregate Demand (AD) equals Aggregate Supply (AS).
- This point decides the equilibrium level of income and employment in the economy.
- Entrepreneurs expand employment as long as AD > AS and reduce it when AS > AD.
- Effective demand may or may not correspond to full employment; it can exist even at underemployment or lead to inflation if demand rises beyond full employment.
Key Points: Importance of Effective Demand
Key Points: Critical Evaluation of Effective Demand
- The term “effective” demand is considered unnecessary and misleading by some economists.
- The theory explains only involuntary unemployment, ignoring other types of unemployment.
- It is less applicable to underdeveloped countries, where the problem is supply-side, not demand.
- Critics argue Keynes reversed cause and effect between demand and employment.
- Overemphasis on expected demand and a direct link between demand and employment is questioned.
