Question

If the supply of final goods is assumed to be infinitely elastic at constant price over a short period of time, Aggregate output is determined solely by the value of Aggregate demand. This is called __________ Principle.

• A. Aggregate supply
• B. Aggregate demand
• C. Effective demand
• D. Perfectly inelastic demand

Answer 1

The Correct Option is C

The question describes a situation in which the supply of final goods is infinitely elastic and remains constant over a short period of time, while the aggregate output depends solely on the value of aggregate demand. This scenario leads to the determination by the principle known as the Effective demand. 

In economics, the concept of 'Effective demand' refers to the idea that the output is determined by the level of demand, especially in a scenario where the supply is perfectly elastic, allowing prices to remain constant as output adjusts to variations in demand. This principle reflects Keynesian economic thought, where demand-driven factors are emphasized in determining economic outcomes.

The correct term that completes the given statement is Effective demand.

Answer 2

The principle of effective demand, introduced by John Maynard Keynes, asserts that in an economy, when prices are constant and supply is elastic, the level of aggregate output is primarily determined by aggregate demand rather than by the available supply.

According to this principle, in the short run, if aggregate demand (the total demand for goods and services in the economy) is insufficient, producers will not have the incentive to produce at full capacity, even if supply could theoretically meet higher demand. In such a situation, the level of output and employment will depend on the amount of demand in the economy, rather than the productive capacity of the economy itself.

This concept is central to Keynesian economics, which argues that government intervention may be necessary to increase aggregate demand during periods of economic downturns, thereby stimulating production, employment, and economic growth. The principle highlights the importance of demand-side factors in determining overall economic activity.