Demand is an economic principle which refers to a consumer’s desire to purchase goods and services and willingness to pay a price for a specific goods or services. In today’s article we are going to know about determination of effective demand. So let’s discuss in details.
Table of Contents
In ordinary sense demand means desire it becomes effective when income is spent on buying consumption goods and investment goods.
The term ‘effective demand‘ refers to the aggregate amount spent on goods and services by the whole community in a specified period. Thus effective demand signifies the total spending of community.
The effective demand is determined by the equality of aggregate demand function (ADF) and aggregate supply functions (ASF).
Aggregate Demand Function (ADF)
The aggregate demand refers to the sale proceeds expected by producers at different level of employment. The amount of money expected by producer’s through the sale of goods produce by worker is called aggregate demand price.
The aggregate demand shows a functional relationship between employment and expected proceeds. It is an increasing function of the level of employment and is expressed as –
AD = f (N)
Where, AD is aggregate demand, N is the level of employment. The slope of AD curve is upward rising from left to right because as the level of employment increases AD also rises.
Aggregate Supply Function (ASF)
The aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period.
It is the total amount of goods and services that firms are willing and able to sell at a given price level in an economy. It is an increasing function of the level of employment and is expressed as –
AS = f (N)
Where, AS is the aggregate supply, N is the level of employment. Aggregate supply is also upward sloping from left to right.
Determination of effective demand
According to Keynes equilibrium level of employment, output and income are determined by the equality of aggregate demand and aggregate supply function.
Let us explain determination of effective demand with the help of the following figure –
In the above figure, employment is measured on the OX axis and expected proceeds are measured on the OY axis. AD and AS are the aggregate demand and aggregate supply function.
Both AD and AS curve intersect each other at point E which is nothing but the point of effective demand where ONF of workers are employed. At this point, the entrepreneurs expectations of profits are maximizes.
At any other point than this the entrepreneurs will either incur losses or earn abnormal profits. At ON1 level of employment, the proceeds expected are more than the proceeds necessary. i.e. RN1>CN1.
This indicates that it is profitable for the entrepreneurs to provide increasing employment to works till ONF level is reached where the proceeds expected and necessary equal at point E.
It would not be however, profitable for the entrepreneurs to increase employment beyond this to NF level because the proceeds necessary exceed the proceed expected, i.e. C1N2>R1N2 and the incur losses.
Thus E is the point of effective demand determines the actual level of employment in the economy which is of underemployment equilibrium.
So friends, this was the concept of determination of effective demand. Hope you get the full details about it and hope you like this article.
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