Assuming for a hypothetical economy, the following data is given :
Income (Y) Consumption (C) Investment (I) Aggregate Demand (AD) 0 20 20 40 100 100 20 – 200 180 20 – 300 260 20 280
Define the term ‘Effective Demand’.
Assuming for a hypothetical economy, the following data is given :
| Income (Y) | Consumption (C) | Investment (I) | Aggregate Demand (AD) |
|---|---|---|---|
| 0 | 20 | 20 | 40 |
| 100 | 100 | 20 | – |
| 200 | 180 | 20 | – |
| 300 | 260 | 20 | 280 |
Define the term ‘Effective Demand’.
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Solution and Explanation
Aggregate demand (AD) is the total planned spending on final goods and services in an economy.
Aggregate supply (AS) is the total value of goods and services that firms plan to produce.
Step 2: Define effective demand:
Effective demand is that level of aggregate demand which is met by the matching aggregate supply in the economy.
It is the point where planned spending and planned output agree. At this point AD = AS.
Step 3: Link it with the given data:
In the completed schedule, AD equals income at Y = 200 (AD = 200). So 200 is the effective demand in this example.
At Y = 100, AD is 120, which is more than income, and at Y = 300, AD is 280, which is less than income. Neither of these is met by the matching supply.
So effective demand is not just any demand. It is the demand that firms can actually meet with their output.
Step 4: Why it matters:
Effective demand decides the equilibrium level of output and employment in the economy. If AD is lower than AS, firms cut output. If AD is higher, firms raise it.
Final Answer:
Effective demand is the level of aggregate demand that is equal to aggregate supply. In the given data it is 200.
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