Effective Demand
Effective demand is the level of demand for goods and services in an economy that is actually backed by the ability and willingness to pay for them, and which therefore results in actual purchases. The concept is central to Keynesian economics, where it plays a key role in explaining the determination of output and employment.[1]
Definition
Effective demand refers not to desire alone, but to demand that is supported by purchasing power. In Keynesian theory, the level of employment and output in an economy is determined by the level of effective demand. If effective demand is insufficient, the economy may settle at an equilibrium with unemployed resources, without any automatic tendency to return to full employment.[1]
The principle of effective demand
The principle of effective demand, a central contribution of John Maynard Keynes in The General Theory of Employment, Interest and Money (1936), states that:
- Aggregate output and employment are determined by aggregate demand.
- The economy can be in equilibrium at less than full employment.
- Government intervention—through fiscal policy and monetary policy—may be needed to raise demand and reduce unemployment.
This contrasts with classical economics, which held that markets would automatically adjust to full employment, a view associated with Say's law (supply creates its own demand).[1]
Related concepts
| Concept | Description |
|---|---|
| Effective demand | Demand backed by purchasing power, determining output and employment. |
| Aggregate demand | Total demand for goods and services in an economy at a given price level. |
| Liquidity Trap | A situation in which monetary policy becomes ineffective at stimulating demand. |
Significance
The principle of effective demand provides the theoretical basis for demand management policies and for the use of government spending and taxation to stabilise the economy. It remains a foundational concept in macroeconomics and in debates about the role of government in the economy.[1]