Many think that effective demand is simply aggregate demand. But that is not true. They are different concepts. It is very important in the current economic sickness to understand the role of effective demand. So I will define effective demand in this post as Keynes saw it.Keynes:
Effective Demand"The value of D at the point of the aggregate demand function, where it is intersected by the aggregate supply function, will be called the effective demand. Since this is the substance of the General Theory of Employment, which it will be our object to expound, the succeeding chapters will be largely occupied with examining the various factors upon which these two functions depend.
"The classical doctrine, on the other hand, which used to be expressed categorically in the statement that “Supply creates its own Demand” and continues to underlie all orthodox economic theory, involves a special assumption as to the relationship between these two functions....
Thus Say’s law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment. If, however, this [Say's law] is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile."
Defining Effective Demand as Keynes saw it
Edward Lambert
crossposted at Angry Bear
3 comments:
There’s no need for the “chapter” to which Keynes refers at the end of the above quote. You need a few sentences as follows.
Say’s law works in a simple non-money economy. E.g. Robinson Crusoe lands on island inhabited by a few families. He pulls fish out of the sea for a living. As a result, the price of fish falls relative to other goods. Hey presto: everyone is fully employed.
In contrast, in a money economy, and given a perfect market, a surplus of labour would result in a rise in the real value of base money or “private sector net financial assets” as MMTers like to put it, and that would bring full employment. (That’s called the “Pigou effect” incidentally). And that ought to bring full employment.
Unfortunately in the real world, wages and hence prices are “sticky downwards”. Thus the Pigou effect only works slowly. So it’s better (as advocated by MMTers) to simply create new fiat, or “base money”, and net spend it.
Lars Syll also has nice post on the subject http://larspsyll.wordpress.com/2014/06/16/what-really-is-effective-demand/
Aggregate supply price of land, has no labour time counterparty.
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