Effective demand

From Academic Kids

Effective demand (in macroeconomics often seen as synonymous with "aggregate demand"), refers to the very simple economic idea that says that it's not enough to want something such as food or luxuries. One must also have money or other assets (purchasing power) or some product to sell in order to make that demand effective.

Many classical economists such as Adam Smith and David Ricardo embraced Say's Law, which says (in very simple terms) that "supply creates its own demand." This says that for every time there's an excess supply (glut) of goods on one market, there's a corresponding excess demand (shortage) on another. That is, there can never be a general glut (http://cepa.newschool.edu/het/essays/classic/glut.htm) in which there is inadequate demand for products at the macroeconomic level.

Economists such as Thomas Malthus and Jean Charles Leonard de Sismondi [1] (http://cepa.newschool.edu/het/profiles/sismondi.htm) struggled to show that Say's Law was wrong. In the process, they created and clarified the concept of effective demand. In the 20th century, John Maynard Keynes and Keynesian economics finished the job. In his economics, effective demand "creates its own supply." If demand is less than supply, this causes an unplanned accumulation of inventories, which leads to a fall in production and of labor employment and incomes. This starts a multiplier process which causes the economy to gravitate to an underemployment equilibrium.

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