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Determination Of Effective Demand

 Determination of Effective Demand

            The level of employment is ascertained at the point where the aggregate demand price equals the aggregate supply price. In other words, it is the point where the entrepreneurs expect to receive equals what they must receive and their profits are maximised. This point is called the effective demand and here entrepreneurs earn normal profits. So long as the aggregate demand price is higher than the aggregate supply price the prospects of getting additional profits are greater when more workers are provided employment.

The proceeds expected (revenue) rise more than the proceeds necessary (costs). This process will continue till the aggregate demand price determines the level of employment and output in the economy. The point of effective demand is nevertheless not necessarily one of full employment but of underemployment equilibrium.

If the entrepreneurs try to provide more employment after this point, the aggregate supply price exceeds the aggregate demand price indicating that the total costs are higher than the total revenue and there are losses. So the entrepreneurs will not employ workers beyond the point of effective demand till the aggregate demand price rises to meet aggregate supply price at the new equilibrium point which may be one of the full employment.

If the aggregate demand price is raised still further, it will lead to inflation for the reason that no increase in employment and output is possible beyond the level of full employment. The following table explains the determination of the point of effective demand.

Level of employment (N)
In 100 thousands

Aggregate Supply Price (Z) in Million $

Aggregate Demand Price (D) in million $

4

430

460

470

480

490

500

310

520

330

540

350

560

370

580

390

5

460

6

490

7

520

8

550

9

580

10

610

The above tablet shows that as long as the aggregate demand price is higher than the aggregate supply price, it is profitable for entrepreneurs to employ more workers, when they expect to receive $460 millions, $480 millions and $500 millions than the proceeds necessary amounting to $430 millions, $460 millions and $490 millions, they will provide increasing employment to 4 hundred thousand, 5 hundred thousand and 6 hundred thousand workers respectively.

But when the proceeds expected equals $520 millions, the level of employment hikes to 7 hundred thousands. This is the point of effective demand. If we assume the level of full employment to be 8 hundred thousand workers in the economy, it will necessitate the drawing up of a new aggregate demand price schedule as shown in the above tablet.

As a consequent, the new point of effective demand is 8 hundred thousand workers for the reason that both the aggregate demand price and the aggregate supply price equal $350 millions. Beyond this point there is no change in the level of employment which is steady at 8 hundred thousand workers.

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