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Principle Of Effective Demand

 Principle of Effective Demand: Aggregate Demand and Aggregate Supply

Introduction

            The logical starting point of Keynes’s theory of employment is the principle of effective demand. In a entrepreneurial economy, the level of employment is based on effective demand. Thus employment results from a deficiency of effective demand and the level of employment can be raised by increasing the level of effective demand.

Aggregate Demand Price

       “The aggregate demand price for the output of any given amount of employment is the total sum of money or proceeds which is expected from the sale of the output produced when that amount of labour is employed.” Thus the aggregate demand price is the amount of money which the entrepreneurs expect to get by selling the output produced by the number of men employed. In other words it refers to the expected revenue from the sale of output produced at a particular level of employment. Different aggregate demand prices relate to different levels of employment in the economy.

       A statement showing the various aggregate demand prices at different levels of employment is called the aggregate demand price schedule or aggregate demand function. “The aggregate demand function.” according to Keynes, “relates any given level of employment to the expected proceeds from that level of employment.”

       The below tablet represents the aggregate demand schedule where it reveals that, with the increase in the level of employment proceeds, expected rise and at lower levels of employment decline. When 900 thousand people are provided employment the aggregate demand price is $560 million and when 250 thousand people are provided jobs, it is $480 million.

       According to Keynes the aggregate demand function is an increasing function of the level of employment and is expressed as D = F (N), where D is the proceeds which entrepreneurs expect from the employment of N men.

Level of Employment
In 100 thousands

Aggregate Demand Price (D)
In Million $

4

460

5

480

6

500

7

520

8

540

9

560

10

580

       The aggregate demand curve can be drawn on the basis of the above schedule. It inclines upward from the left to right for the reason that the level of employment increases aggregate demand price also rises, shown as AD curve in the upcoming diagram 1.

                                   

Aggregate Supply Price

            When an entrepreneur gives employment to a definite amount of labour, it requires certain quantities of co-operant factors like land, capital, raw materials etc. which will be paid remuneration along with labour. Thus each level of employment involves certain money costs of production including normal profits which the entrepreneur must cover. “At any given level of employment of labour aggregate supply price is the total amount of money which all the entrepreneurs in the economy, taken together must expect to receive from the sale of the output produced by that given number of men, if it is to be just worth employing them.”

            In brief, the aggregate supply price refers to the proceeds necessary from the sale of output at a particular level of employment. Thus each level of employment in the economy is related to a particular aggregate supply price and these are different aggregate supply prices for different levels of employment.

            A statement showing the various aggregate supply prices at different levels of employment is called aggregate supply price schedule or aggregate supply function. In the words of Prof. Dillard, “The aggregate supply function is a schedule of the minimum amounts of proceeds required to induce varying quantities of employment.” The below tablet reveals the aggregate supply schedule,

Level of Employment (N)
in 100 Thousands

Aggregate Supply Prize (Z)
In Million $

4

430

5

460

6

490

7

520

8

550

9

580

10

610

            The above table reveals that the aggregate supply prices rise with the hike in the level of employment. If entrepreneurs are to provide employment to 400 thousand workers, they must receive $430 millions from the sale of output produced by them. It is only when they expect to receive minimum amounts of proceeds ($460 millions, $490 million and $520 million) that they will provide employment to more workers (5, 6 and 7 hundred thousand dollars respectively).

            But when the economy reaches the level of full employment (at 800 thousand workers, the aggregate supply price ($550 million, $580 million and $610 millions) continues to increase but there is no further is an increasing function of the level of employment and is expressed as Z = ɸ N, Z is the aggregate supply price of the output level from employing N men.

            The aggregate supply curve can be drawn on the basis of the schedule. It inclines upward from left ro right for the reason that the necessary expected proceeds hikes; the level of employment also rises. But when the economy reaches the level of full employment, the aggregate supply curve becomes vertical. Even with the hike in the aggregate supply price, it is not possible to provide more employment as the economy has attained the level of full employment.

                                   

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