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Effective Demand

The concept of effective demand is the logical starting point of Keynes Theory of Employment. Effective demand manifests itself in the aggregate expenditure of the community. The aggregate expenditure of the economy comprises the consumption expenditure of households, investment expenditure of firms, and the government expenditure. The aggregate expenditure depends upon the level of real income. Larger the level of real income, the more will be the aggregate expenditure, and vice versa.

Effective demand, thus is equal to the level of national income, i.e., the aggregate factor income in the form of wages, rent, interest, profit, etc. the income earned by the factors is spent on the goods and services produced in the economy. Therefore, effective demand can also be expressed in terms of the total value of output in the economy.

It should, however, be remembered that every level of demand is not effective. Only that level of demand is effective which is set by a corresponding supply. In case, the level of aggregate expenditure or demand is high but adequate supply of good and service is not forthcoming, the level of effective demand and employment will remain very low. Therefore, the equilibrium level of effective demand or full employment is attained when the aggregate demand equals the aggregate supply.