Jesper Jespersen untangles the concept and shows how Keynes, by taking uncertainty seriously, contributed to forming an analytical alternative to the prevailing neoclassical general equilibrium framework:What — really — is ‘effective demand’?
Lars P. Syll | Professor, Malmo University
Download the paper, Effective Demand: Uncertain expectations, profitability and financial circuit by
Jesper Jespersen, Roskilde University
4 comments:
Isn't Keynes's distinction between effective demand and aggregate demand simply the distinction between one value of a function and the function itself?
Yes, "effective demand: is defined as the intersection point between supply function (Z) and demand function (D) with the axial parameters being output and employment. Here's Keynes:
"Let Z be the aggregate supply price of the output from employing N men, the relationship between Z and N being written Z = φ(N), which can be called the Aggregate Supply Function.[5] Similarly, let D be the proceeds which entrepreneurs expect to receive from the employment of N men, the relationship between D and N being written D = f(N), which can be called the Aggregate Demand Function.
"Now if for a given value of N the expected proceeds are greater than the aggregate supply price, i.e. if D is greater than Z, there will be an incentive to entrepreneurs to increase employment beyond N and, if necessary, to raise costs by competing with one another for the factors of production, up to the value of N for which Z has become equal to D. Thus the volume of employment is given by the point of intersection between the aggregate demand function and the aggregate supply function; for it is at this point that the entrepreneurs’ expectation of profits will be maximised. 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. ."
Keynes, GT, ch 3, 1 Emphasis added
Say's law says that supply (Z) is determinative since investment produces income and all income is spent ("hot potato" effect). Therefore, given loanable funds, the interest rate determines investment and therefore can be used as a control lever, which is the basis of monetarism in general.
Keynes observed that some income is saved owing to uncertainty so there may be a discrepancy that vitiates Say's law. Firms adjust supply to changes in anticipated propensity to consume from income. Fiscal policy can offset changes in non-government consumption/saving ratio.
Keynes interpreted Say's Law as saying that φ(N)= f(N) for all values of N.
...chapter [3] contains Keynes’ “general theory” in a nutshell. All the concepts mentioned in this chapter will be brought up and explained in the subsequent chapters.
A few definitions, which we will return to throughout the book,
Factor Costs: The money amount paid out by the entrepreneur (for Keynes, the entrepreneur is one who commands the factors of production) to purchase the factors of production. This does not include money paid out to other entrepreneurs for complimentary capital goods (so, we are talking about only the original factors of production);
User Cost: This is an intertemporal opportunity cost. It is equal to the money paid out to other entrepreneurs and the sacrifice incurred by using these capital goods, rather than keeping them idle;
Income: This is profit, or the (monetary) “value” of the resulting output minus the factor cost and user cost ([price][output] – [factor cost + user cost]).
Total Income (Proceeds): Similar to the concept of “aggregate surplus,” or income plus factor cost (since the factor cost is income for owners of these factors).
Aggregate Supply Price: The expectations of minimum total income sufficient to justify the employment of one’s resources.
Thus, given technique, available resources, and factor cost the entrepreneur will employ a number of resources decided by the aggregate supply price. In other words, the entrepreneur will look to maximize proceeds minus factor costs.
Z = aggregate supply price of output from employing N men, or Z = φ(N) — this is the aggregate supply function.
D = proceeds expected from employing N men, such that D = f(N) — this is the aggregate demand function.
If D>Z, entrepreneurs will increase employment (N will be a greater figure) until D = Z. Employment is decided where D and Z intersect. This Keynes calls “effective demand,” or the equilibrium employment of resources that can be expected under certain conditions.
Finally, Keynes goes into another criticism of [neo]classical theory (or Say’s Law), where “[s]upply creates its own [d]emand.” Keynes interprets this to mean that φ(N) and f(N) must be equal at all levels of N, and when Z increases so does D by an equal amount. Instead of having a single possible equilibrium, this relationship suggests an infinite number of possible equilibrium values, where the volume of employment is determined only by the upper limit of the marginal disutility of labor. Keynes’ main argument against Say’s Law is that aggregate demand is not always equal to aggregate supply...."
This is where Keynes sees a major problem with advanced, growing, capitalist economies. He suggests that these economies suffer from insufficient effective demand even before full employment is achieved, even though real wages are higher than the marginal distutility of labor. The wealthier the community, or the greater φ is, the greater will be the gap between φ and χ. According to Keynes, this is because the savings of the wealthy outstrip the consumption of the poor, and the gap can only be fulfilled by a growing D2. The problem here, writes Keynes, is that as more capital is accumulated the rate of interest will have to fall in order to induce more investment — Keynes postulates that this will not occur (to a sufficient degree). We are introduced to concepts that Keynes will explore in greater detail later: the marginal efficiency of capital, the liquidity preference theory of interest, the propensity to consume, and his theory of prices.
https://tinyurl.com/oh2xm3e Emphasis added.
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