Question

What is meant by "Effective Demand"?

Hint:

Don't confuse "demand" with "effective demand." Demand is just a desire backed by ability to pay. Effective Demand is the specific point where the economy's total spending (demand) equals its total production (supply).

Answer 1

Step 1: Understanding the Concept:
The question asks for the definition of "Effective Demand," a central concept in Keynesian macroeconomics.

Step 2: Detailed Explanation:
Effective Demand is the level of aggregate demand in an economy that is equal to the aggregate supply. It is the point where the total demand for goods and services matches the total supply of goods and services.
According to John Maynard Keynes, the level of employment in an economy is determined by the level of effective demand. The equilibrium level of income and output is established where: \[ \text{Aggregate Demand (AD)} = \text{Aggregate Supply (AS)} \] Keynes argued that unemployment arises due to a deficiency of effective demand. If AD is less than AS at the full employment level, producers will cut back on production, leading to unemployment.
Effective demand is composed of two components: \begin{itemize} \item Consumption expenditure (C) \item Investment expenditure (I) \end{itemize} Thus, \(AD = C + I\).

Step 3: Final Answer:
Effective Demand is the level of aggregate demand at which it is equal to the aggregate supply, thereby determining the equilibrium level of income, output, and employment in the economy.