State the meaning of ‘Effective Demand’.
State the meaning of ‘Effective Demand’.
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Solution and Explanation
In macroeconomics, the economy has two sides. Aggregate Demand (AD) is the total planned spending on goods and services. Aggregate Supply (AS) is the total value of output that firms plan to produce.
Step 2: Linking demand with supply:
Many levels of AD are possible in an economy. But firms can only sell what they can produce. So only that level of AD which the economy can actually supply matters for deciding output and employment.
Step 3: Defining Effective Demand:
Effective Demand is that level of Aggregate Demand which is met by the corresponding Aggregate Supply in the economy.
At this level, what households and firms plan to buy equals what firms plan to produce. So the economy settles here.
It is the level of demand that is actually effective in deciding the level of output and employment.
Final Answer:
Effective Demand is the level of Aggregate Demand that is matched by the corresponding Aggregate Supply in the economy (the point where AD = AS).
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