Q.Explain the concept of effective demand.

Effective demand is the level of aggregate demand that equals aggregate supply, determining the economy's equilibrium level of income and employment. Keynes placed it at the point where the aggregate demand price equals the aggregate supply price, and argued that employment depends on effective demand rather than on supply.

Meaning

In Keynes's theory, the volume of employment in an economy depends on effective demand. Effective demand is determined by the interaction of two forces: aggregate demand and aggregate supply.

• Aggregate Demand Price is the total amount of money that all entrepreneurs together expect to receive from the sale of output produced by a given number of workers.
• Aggregate Supply Price is the total amount of money that all entrepreneurs together must receive to just cover the cost of employing that number of workers.

Effective demand

As employment increases, aggregate demand price and aggregate supply price both change. Effective demand is the particular value of aggregate demand at which the aggregate demand price equals the aggregate supply price. At that point entrepreneurs have no incentive either to expand or to contract employment, so it fixes the equilibrium level of output and employment.

Significance

• Employment rises or falls with the level of effective demand.
• If effective demand is low, equilibrium is reached below full employment, resulting in involuntary unemployment. …