Effective demand

In economics, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as aggregate demand. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.

In economics, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as aggregate demand. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.

History

Classical economist David Ricardo embraced Say's law, suggesting, in Keynes's formulation, that "supply creates its own demand". According to Say's law, for every excess supply (glut) of goods in one market, there is a corresponding excess demand (shortage) in another. This theory suggests that a general glut can never be accompanied by inadequate demand for products on a macroeconomic level. In challenging Say's law, Thomas Malthus, Jean Charles Leonard de Sismondi and other 19th century economists argued that "effective demand" is the foundation of a stable economy. Responding to the Great Depression of the 20th century, in the 1930s Michał Kalecki and John Maynard Keynes concurred with the latter theory, suggesting that "demand creates its own supply" and developing a comprehensive theory of effective demand. According to Keynesian economics, weak demand results in unplanned accumulation of inventories, leading to diminished production and income, and increased unemployment. This triggers a multiplier effect which draws the economy toward underemployment equilibrium. By the same token, strong demand results in unplanned reduction of inventories, which tends to increase production, employment, and incomes. If entrepreneurs consider such trends sustainable, investments typically increase, thereby improving potential levels of production. In the 1960s, Robert Clower and Axel Leijonhufvud did further work on effective demand, and in the 1970s Robert Barro and Herschel Grossman published a well-known model of spillover effects upon effective demand.

References

Further reading

Buiter, Willem, and Lorie, Henri, "Some unfamiliar properties of a familiar macroeconomic model," The Economic Journal, December 1977, 743–754. Huw Dixon, Reflections on New Keynesian Economics, Surfing Economics, 2001, chapter 4. Korliras, Panayotis, "A disequilibrium macroeconomic model," Quarterly Journal of Economics, February 1975, 56–80. Lambert, Edward, “Modeling an Effective Demand Limit to the Business Cycle” Effective Demand blog. 12/28/2014. Lambert, Edward, “Synopsis of Effective Demand.” Effective Demand blog. 9/24/2015. Lorie, Henri, "Price-quantity adjustments in a macro-disequilibrium model," Economic Inquiry, April 1978, 265–287. Tucker, Donald, "Credit rationing, interest rate lags, and monetary policy speed," Quarterly Journal of Economics, February 1968, 54–84. Tucker, Donald, "Macroeconomic models and the demand for money under market disequilibrium," Journal of Money, Credit and Banking, February 1971, 57–83. Varian, H., "The stability of a disequilibrium IS-LM model," Scandinavian Journal of Economics, 1977(2), 260–270. Vianello, F. [1989], “Effective Demand and the Rate of Profits: Some Thoughts on Marx, Kalecki and Sraffa”, in: Sebastiani, M. (ed.), Kalecki's Relevance Today, London, Macmillan, .

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