Q.Distinguish between Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS).

Effective demand is the level of aggregate demand that equals aggregate supply — the point where the Aggregate Demand Price and Aggregate Supply Price are equal. At this point the equilibrium level of employment and national output is determined in the Keynesian theory.

Meaning

In the Keynesian theory of employment, the level of employment depends on aggregate demand. As the level of employment increases, both the Aggregate Supply Price (the amount producers must receive to offer that employment) and the Aggregate Demand Price (the amount they actually expect to receive from sales) change. The particular level at which the Aggregate Demand Price becomes exactly equal to the Aggregate Supply Price is called effective demand.

Explanation

Effective demand is thus not just any demand but the demand that is actually realised and matched by supply. The level of employment fixed at the point of effective demand is the equilibrium level of employment; it need not correspond to full employment. If effective demand is low, equilibrium is reached with unemployment; raising effective demand (through consumption and investment, and if necessary government spending) increases employment.

Effective demand depends on two components — consumption expenditure and investment expenditure — so it rises when either of these increases.

Effective demand is the level of aggregate demand at which aggregate demand price equals aggregate supply price. At this point entrepreneurs have no incentive to change the level of employment, so effective demand determines the equilibrium level of income and employment.

Meaning

In Keynes's theory, the level of employment depends on effective demand, which is settled by the interaction of aggregate demand and aggregate supply.

• Aggregate demand price is the total receipts entrepreneurs expect from selling the output of a given number of workers.
• Aggregate supply price is the total receipts entrepreneurs must get to just cover the cost of employing that number of workers.

Effective demand is the value of aggregate demand where the aggregate demand price equals the aggregate supply price. At that point employment is in equilibrium, because entrepreneurs neither gain by expanding nor by contracting output. If effective demand is low, the economy reaches equilibrium below full employment, causing unemployment.

This concept in the AP Intermediate 1st-year Economics course aligns with the Keynesian macroeconomics content of the NCERT/CBSE curriculum.

Effective demand is the level of aggregate demand that equals aggregate supply; at this equilibrium point the entrepreneurs' expected sale proceeds are just realised. In Keynes's theory it determines the level of output and employment in the economy.

Meaning

In Keynes's theory of employment, effective demand is the point at which aggregate demand equals aggregate supply.

• Aggregate demand is the total amount that all buyers in the economy are expected to spend.
• Aggregate supply is the total value of output that producers are willing to supply at various levels of employment.

Entrepreneurs go on employing workers and producing output up to the point where their expected sale proceeds (aggregate demand) just equal the cost of producing that output (aggregate supply). This point of equality is called effective demand.

It is 'effective' because it is the demand that is actually realised. Since the level of employment depends on the level of effective demand, more effective demand means more employment. Unemployment arises when effective demand is deficient (less than that needed for full employment).